Emerging Markets ETF Outlook: Opportunities, Risks, and Best Funds

Key Data Points

What Are Emerging Markets

Emerging markets are countries with developing economies that are transitioning toward becoming advanced, industrialized nations. The MSCI Emerging Markets Index, the most widely followed EM benchmark, includes 24 countries: China, India, Taiwan, South Korea, Brazil, Saudi Arabia, South Africa, Mexico, Indonesia, Thailand, and others. These economies collectively represent approximately 40% of global GDP but only about 12% of global stock market capitalization, suggesting significant room for market growth.

Emerging market economies are characterized by younger populations, faster GDP growth rates, expanding middle classes, and increasing integration into the global economy. Average GDP growth in emerging markets has exceeded 4% to 5% annually over the past two decades, roughly double the rate of developed economies. This faster economic growth is the fundamental investment thesis for EM exposure.

Historical Returns and Volatility

Emerging market stocks have delivered compelling long-term returns but with significantly higher volatility than developed markets. From 2000 to 2010, emerging markets were the best-performing major asset class, with the MSCI Emerging Markets Index returning approximately 16% annually compared to roughly -1% for the S&P 500. This outperformance attracted massive investor inflows.

However, from 2011 to 2024, emerging markets significantly underperformed developed markets, particularly the US. The MSCI EM Index returned approximately 3% to 4% annualized during this period compared to roughly 13% for the S&P 500. This underperformance was driven by a strong US dollar, slowing Chinese economic growth, commodity price declines, and the dominant performance of US technology stocks. The volatility of EM returns is approximately 50% higher than US stock volatility, with drawdowns during crises frequently exceeding 40% to 50%.

China's Dominant and Complex Role

China has represented 25% to 35% of most emerging market indexes in recent years, making it by far the largest single-country exposure. This concentration means that investing in a broad EM ETF is heavily a bet on Chinese economic and political outcomes. China's regulatory crackdowns on technology companies in 2021 wiped hundreds of billions of dollars from companies like Alibaba and Tencent, dragging down the entire EM asset class.

Some investors now prefer to separate their China exposure from broader emerging market investing. ETFs like EMXC (iShares MSCI Emerging Markets ex China ETF) allow investors to access EM growth while avoiding concentrated China risk. Alternatively, dedicated China ETFs like MCHI or FXI can be used to set a specific China allocation separate from the broader EM position. India, tracked by ETFs like INDA, has emerged as the fastest-growing major EM economy and increasingly attracts investor attention as an alternative to China-heavy EM funds.

Best Emerging Market ETFs

VWO (Vanguard FTSE Emerging Markets ETF) is the largest EM ETF by assets with approximately $80 billion under management and an expense ratio of 0.08%. It provides broad EM exposure across approximately 5,700 stocks. IEMG (iShares Core MSCI Emerging Markets ETF) at 0.09% is the next largest, tracking the MSCI EM Investable Market Index which includes small-cap stocks for broader coverage.

For more targeted approaches, SCHE (Schwab Emerging Markets Equity ETF) at 0.11% provides a low-cost alternative. EMXC at 0.25% removes China exposure for investors who want to manage that allocation separately. DEM (WisdomTree Emerging Markets High Dividend Fund) at 0.63% focuses on EM dividend payers for income-seeking investors. AVEM (Avantis International Equity ETF) at 0.33% applies a value and profitability factor tilt to EM selection, targeting higher expected returns.

How Much EM Exposure Is Appropriate

Most financial advisors recommend emerging market exposure of 5% to 15% of a total equity portfolio. Vanguard's target-date funds allocate approximately 18% to 20% of their international equity sleeve to emerging markets, which translates to roughly 7% to 8% of the total equity allocation. This represents a meaningful but not dominant position.

For beginning investors, the simplest approach is to use VXUS or IXUS as a single international holding, which already includes both developed and emerging market stocks in market-cap-weighted proportions. Approximately 25% of VXUS is allocated to emerging markets. This provides automatic EM exposure without requiring a separate allocation decision. As your portfolio grows and your understanding of international markets deepens, you can consider separating developed and emerging market allocations for more precise control over your geographic risk profile.

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