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What is an 'Emerging Market ETF'

An emerging market ETF is an exchange-traded fund that focuses on the stocks of emerging market economies, such as Latin America, Asia and Eastern Europe. The underlying indexes tracked by emerging market ETFs vary from one fund manager to another, but all should be passively managed and contain equities from multiple countries, unless otherwise stated. 

BREAKING DOWN 'Emerging Market ETF'

Emerging market ETFs are comprised of emerging market stocks, which can offer compelling growth opportunities over time for investors. Many investors with longer time horizons simply cannot afford to miss out on the higher returns offered by some emerging market economies. These nations are typically identified by high growth rates and many have surpluses of rich natural resources that are heavily consumed by the developed world.

While investing in emerging markets can provide financial opportunity for investors, these markets may come with a steep learning curve. Attempting to navigate influences like geopolitical issues and less transparency in emerging market countries are all reasons that the average investor might opt for an emerging market ETF instead of trying to locate and evaluate individual securities in emerging markets. With an emerging market ETF, an investor can target a specific portion of an emerging market based on regional preferences or a specific asset class. Within the broad class of emerging market ETFs, there are funds that focus on certain market-capitalizations, high-dividend stocks, or funds with high allocations towards specific sectors. 

Pros and Cons of an Emerging Market ETF

Many investors value the diversification benefits of emerging market ETFs in addition to their ability to generate return. Because they invest in equities in emerging markets, emerging market ETFs tend to be less correlated to U.S. equities than other ETFs that primarily feature equities in their lineups. Emerging market ETFs also tend to be more liquid than an emerging market mutual fund, because ETFs can be bought and sold instantly on an exchange, whereas a mutual fund can only be redeemed at the price set at the end of the day’s trading. Trading costs tend to be higher when investing directly in local stock exchanges in emerging market nations.

Investors should be aware of multiple potential risks before investing in emerging markets. These markets are often more prone to volatility than their more developed counterparts. Emerging markets are also vulnerable to geopolitical and governance risk. Also, expense ratios for emerging market ETFs may be slightly higher than the average for domestic-focused funds.

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