What is an Emerging Markets ETF?

An emerging markets exchange-traded fund (ETF) is one that invests in the shares of companies listed on the stock exchanges of so-called "emerging market" countries, with the nations of Brazil, Russia, India and China (BRIC) being perhaps the best-known examples. As is true for all ETFs, by definition emerging markets ETFs are passively managed and designed to track the performance of a widely almost always publicly available index. Within the emerging markets ETF sector, particular funds might narrow their investment choices further, such as by concentrating their investments in a narrow range of countries, such as a BRIC ETF, in high-capitalization or low-capitalization companies or specific economic sectors or by pursuing specific investment objectives, such as growth or income.

Emerging markets countries were once commonly known as lesser-developed countries (LDCs). Definitions have changed, however, and some people draw distinctions between emerging markets and lesser-developed countries. By way of contrast, a country with an emerging market economy is considered one which has exhibited and continues to exhibit relatively rapid economic growth and development of a market-driven economy, in other words, one modeled along capitalist lines. LDCs, on the other hand, have not and do not exhibit these broadly defined characteristics. In contrast to emerging markets ETFs, international ETFs invest in listed shares from countries with both developed and emerging markets.

What makes ETFs attractive as an investment vehicle is also generally true for any emerging markets ETF. Being passively managed and designed to track an index keeps the costs of ETFs down as compared to actively managed mutual and closed-end investment funds, and it offers a simple, easy and effective way to gain relatively broad exposure to one or more emerging markets countries' stock markets. That said, an emerging markets ETF typically has higher expenses and charges higher fees than ETFs that invest solely inside the United States or other developed markets with more open and better-developed financial sectors, communications infrastructures and a history of international investment and trade flows between them. Generally speaking, it simply costs more to invest in shares listed on stock markets in emerging market countries, despite the tremendously greater ease and lower costs of doing so as a result of advances in digital telecommunications and computing technology. Government regulations can play a big role in the cost equation.

In addition to the risk that emerging market economies might falter and stock prices fall, investors in an emerging markets ETF also should take into account that they are assuming currency risk exposure when they invest in an emerging markets ETF. Emerging market ETFs are listed on U.S. exchanges, and they are priced in U.S. dollars, but the stock markets and shares in which these funds invest are not. Hence, investing in an emerging markets ETF also means that investors are exposed to the risk, as well as the gain, that might result from changes in foreign exchange rates.