By Aniruddha Bose

Should you invest in developing countries for your long-term goals? Investors now have the option to take exposure to emerging markets like Brazil, Indonesia, Thailand, Mexico, South Africa, and others by investing in emerging market funds that in turn invest into global emerging market funds through the feeder route.

These funds claim to offer diversification benefits beyond domestic markets. Interestingly, the four emerging market funds that are available to investors have drastically underperformed domestic equities over the past 3-5 years. And while it is true that past performance is not a sound indicator of future performance, we firmly believe that any retail investor who has a cumulative portfolio of less than $500,000 (Rs. 4 Crores) does not need to look beyond domestic equity funds for their long-term goals. Here’s why.

For one, emerging market funds carry unforeseen country-specific risks as well as currency risks. That is a lot of multi-layered diversification to deal with! And remember, diversification works both ways – when you diversify in a fund that invests across 20-25 emerging markets or more, sovereign risks in 2-3 countries at any point in time could result in a drag in the overall fund returns over a long period of time even if other countries in the portfolio outperform.

Also, global shocks such as a geopolitical event or a pandemic could disrupt entire clusters of emerging markets for extended periods – and having such an over diversified, non-specific strategy could actually work against investors in the long run.

Secondly, we have observed that investors typically do not succeed with emerging market funds because these funds behave very differently from domestic equity funds, and this end up frustrating them. For example, emerging market funds have performed very poorly over the past 3-5 years, returning barely 2-4% annualized returns for most investors depending upon their entry point.

Most domestic equity funds, on the other hand, have done very well in the same period. These kinds of divergences trigger a host of behavioral biases that would pretty much guarantee to invest failure even if fund performances pick up because remaining invested is so difficult!

And lastly, when the future of domestic markets is looking bright, why look beyond? Several macros are pointing towards a bright phase for the domestic economy, and that’s all the more reason to build a portfolio that’s focused on domestic equities instead of branching out to other emerging markets that have unforeseen risks, are inefficiently diversified, and trigger greed/fear-based reactions.

In the end – “why” you invest matters much more than “where” you invest. Are you investing for clearly defined goals or in an ad hoc way? Are you resilient through market cycles? Do you succumb to greed or fear-driven investing mistakes? These are some important factors that will hugely impact your end result, regardless of the fund that you have selected.

For successful investing, perseverance, and the ability to stay invested through lengthy periods of time is key. Remember, it is not the products that create wealth in the long run, but the ability to stay invested by having clearly defined goals in place, which in turn lend clarity and purpose to your investing journey.

(Author is Chief Business Officer, FinEdge)