Some investors may be wary of incorporating the emerging markets into their portfolios as these less developed economies are seen as a large source of uncertainty and risk. However, the broad developing markets may actually be less risky than U.S. markets. Since 2002, the one year rolling standard deviation of returns for the emerging markets has been lower than that of the MSCI U.S. index over 75% of the time. The lower risk may be associated with the diverse nature of the emerging market category.
“We think the explanation comes when one considers the uncorrelated nature of the markets included in the index,” according to Deutsche Asset Management. “Unlike in Europe, for example, the countries that make up the emerging markets baskets in the well-known indexes are particularly geographically and economically diverse.”
For instance, the average correlation between between Brazilian stocks and those of the other seven larges MSCI EM Index components is only 0.35 – a 1 reading means perfect correlation while a 0 reading reflects zero correlation.
Investors interested in international exposure have a number of ETF options available to them. For developed market exposure, the iShares MSCI EAFE ETF (NYSEArca: EFA) and Vanguard FTSE Developed Markets ETF (NYSEArca: VEA) are two largest ETFs that target developed Europe, Australia and Asian economies.
Additionally, Deutsche also offers the Deutsche X-trackers FTSE Developed ex US Comprehensive Factor ETF (NYSEArca: DEEF), which includes developed foreign market exposure but selects components based on a broad set of five factors, including quality, value, momentum, low volatility and size.
For emerging market exposure, the popular Vanguard FTSE Emerging Markets ETF (NYSEArca: VWO) tracks the FTSE Emerging Index and the iShares MSCI Emerging Markets ETF (NYSEArca: EEM) follows the MSCI Emerging Markets Index.
Additionally, the Deutsche X-trackers FTSE Emerging Comprehensive Factor ETF (NYSEArca: DEMG) also provides emerging market exposure and selects components based on the same set of five factors as DEEF.
When constructing a investment portfolio, investors should not forget the diversification benefits of including international exposure.