What are Emerging Market Funds?

An emerging market fund refers to an exchange-traded or mutual fund that places most of its investments in the financial markets of developing countries. The term "emerging market" was coined by the investment community to refer to developing countries that showed promising growth prospects. Emerging market funds carry the potential for very high returns, but are considered a high risk investment due to the uncertainty of economies in these countries.

Emerging market investment focuses on countries with rapidly developing economies. Between 1980 and 2006, most emerging market funds invested assets in countries located in areas such as Africa, Latin America, Asia, and Eastern Europe. To invest in emerging economies, the investor can place assets in one single country or disperse assets in several countries with growing economies. As more developing countries become eager to join the global economy, more opportunities for emerging market investment become available.

Investing in emerging market funds may pose a substantial risk for loss. Developing countries tend to be more susceptible to political or economic upheaval. These countries tend to have low per-capita incomes and are in the early stages of building an industrial and commercial base. The financial markets in these countries are usually still fragile and have not yet developed a leveled or steady growth rate, leaving much room for error as well as steep and sudden market drops. Obtaining information on trading securities in emerging markets can be challenging, and it is usually advisable to obtain such information from some type of professional investment manager.

There are several alternatives for investment in emerging market funds. A mutual fund investor will typically begin investing in a fund by placing a simple addition to an existing portfolio. Usually, emerging market exposure is capped at 5% or 10% of a portfolio's risk-based assets.

Exchange-traded funds (ETFs) are another popular method of emerging market investment. ETFs are securities that track assets like an index fund, but they trade like a stock on an exchange. Often these funds offer passive exposure to a higher percentage of total domestic market capitalization for a particular country.

Investors may also consider investing in emerging market funds by using American Depository Receipts to trade publicly on US stock exchanges. This method allows more freedom for developing unique investments and controlling exposure to foreign firms. It may require an abundance of time and effort in order to perform a proper bottom-up fundamental analysis, however.