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What Is Your Emerging-Markets Allocation?

Investors' average 3% to 4% allocation is low given the rising importance of emerging markets.

Patricia Oey 30 September, 2014 | 9:33
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Using aggregated Morningstar fund data (which includes U.S.-domiciled equity and bond mutual funds and exchange-traded funds) as a proxy for the average U.S. investor, as of August 2014, investors have about a 3% to 4% allocation in emerging-markets equities and just less than a 1% allocation in emerging-markets debt. These weightings are in line with what we see in some of the largest world-allocation funds, such as American Funds Capital Income Builder CAIBX and BlackRock Global Allocation MDLOX. Given the rising importance of emerging-markets economies, and their faster growth rates relative to the developed world, these allocations seem a bit low.

The State of Emerging-Markets Allocations
The main argument for investing in international securities is for diversification through exposure to different countries and economies, slightly different sector weightings, and foreign currencies. Using the Morningstar Moderate Target Risk Index (a global portfolio with a 60/40 mix of stocks and bonds) as a benchmark for the average investor, a target allocation to emerging-markets equities (including stocks from Taiwan and South Korea) would be 4.5% of the value of a 60/40 stock-bond portfolio, or about 8% of the equity portion of that portfolio. This 8% allocation is slightly below a market-capitalization-based weighting, as emerging-markets equities account for 10% of the global equity market, as represented by the MSCI All-Country World Investable Market Index. Regardless of how one measures market weight, these figures are all significantly below emerging markets' collective share of global GDP, which is approximately 35%. This figure provides some perspective on the asset class' long-term growth potential.

Investors who eschew emerging-markets funds in favor of broader international-equity funds generally have a very small allocation in emerging markets. According to Morningstar fund data, foreign large-blend funds have an average 8% allocation in emerging-markets equities, which is actually slightly lower than the 10% average during the last five years. This decline is partly due to emerging markets' relative underperformance during the last few years and a reluctance to rebalance, as emerging-markets equities continue to underperform and U.S. equities continue to outperform. Within the MSCI All-Country World ex USA Investable Market Index (a cap-weighted index of stocks from 45 countries, excluding the U.S.), emerging markets account for 20%.

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About Author

Patricia Oey  Patricia Oey is an ETF analyst at Morningstar.

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