From Templeton to Today: The Evolution of Emerging Market Index Funds

Emerging Market Index Funds: A Historical Perspective

Investing in emerging market index funds is a popular strategy among investors. These funds provide exposure to the economies of developing countries, which are expected to grow faster than developed economies over time. But where did these index funds come from, and how have they evolved?

The origins of emerging market investing can be traced back to the early days of mutual fund investing in the 1950s and 1960s. At that time, most mutual funds focused on U.S. stocks or bonds. However, as global trade expanded and international markets became more accessible to U.S. investors, some fund managers began looking beyond their home market.

One of the pioneers in this area was John Templeton, who launched his first international fund in 1954. Templeton believed that there were opportunities for superior returns outside the U.S., particularly in countries with low valuations and high growth potential.

Templeton’s approach was based on fundamental analysis rather than indexing; he would seek out undervalued companies with strong growth prospects, regardless of their country of origin. His approach proved successful; his flagship Templeton Growth Fund delivered an average annual return of over 14% from its inception until he retired in 1992.

While Templeton’s approach worked well for individual stock picking, it wasn’t scalable for large institutional investors like pension funds or endowments who wanted exposure to entire markets or asset classes. As a result, index investing began to gain popularity as a way to achieve broad-based exposure at lower costs.

The first major emerging market index was created by Morgan Stanley Capital International (MSCI) in 1988. The MSCI Emerging Markets Index tracks the performance of stocks from over two dozen developing countries including Brazil, China, India, Russia and South Africa.

At its launch date however it only consisted of ten countries namely Argentina, Brazil Chile Colombia Korea Malaysia Mexico Philippines Taiwan and Thailand. The index was designed to be representative of the emerging market asset class, with a focus on large and mid-sized companies.

The MSCI Emerging Markets Index quickly became popular among institutional investors seeking exposure to these markets, but it wasn’t until the early 2000s that index funds targeting this asset class began to emerge.

One of the first emerging market index funds was launched by Barclays Global Investors (now BlackRock) in 2003. The iShares MSCI Emerging Markets ETF (EEM) tracks the same MSCI Emerging Markets Index mentioned above, at present EEM is one of the largest Emerging Market ETF with assets over $36 billion dollars as of August 2021

Soon after its launch other financial firms such as Vanguard and State Street Global Advisors also introduced similar funds based on various indices like FTSE Russell or S&P Dow Jones Indices which were created later than MSCI’s EM indices.

The popularity of emerging market index funds grew rapidly in the years following their launch. One reason for this growth was increased awareness about the potential benefits of diversification; investing in developing countries offered diversification benefits given that they had low correlation with developed markets such as US, UK or Japan etc.

Additionally, many investors saw these markets as offering higher growth potential compared to developed economies. For example between January 1995 and July 2021 ,the average annualized return for MSCI EM Index stood at around 10%, while S&P500 returned around 9% per annum.

However it’s important to note that past performance is not indicative of future results and there could be periods when returns from an EM investment may lag those from developed economies which happened most recently during COVID pandemic due to supply chain disruptions leading into slower economic activity across many EM countries.

Today, there are dozens of emerging market index funds available across different asset classes ranging from equities to bonds reflecting investor demand for specific types of exposures within this asset class.

One of the key advantages of investing in emerging market index funds is diversification. By investing across a range of countries and companies, investors can spread their risk and reduce the impact of any one company or country experiencing economic challenges.

Another advantage is low costs; most index funds charge significantly lower fees than actively managed funds which rely on human expertise to pick stocks resulting in higher expense ratios. This makes it easier for investors to build diversified portfolios at lower cost.

However there are some potential risks associated with investing in Emerging Markets as they tend to be more volatile compared to developed markets due to political instability, currency fluctuations, poor corporate governance practices etc. Therefore it’s important that investors understand these risks before making any investment decisions.

In summary, emerging market index funds have come a long way since their inception over three decades ago. As global trade continues to expand and developing economies grow increasingly interconnected, these funds will likely remain an important part of many investor’s portfolios seeking growth opportunities outside developed economies over time.