Why Emerging Markets Are an Essential Opportunity

The Structural Case for EM: Demographics, GDP Growth, and Market Mispricing

Investing internationally has become a common practice, allowing investors to secure stakes in firms across the globe, typically through exchange-traded funds (ETFs) or mutual funds. However, the real structural opportunity for long-term capital appreciation resides within developing markets, often referred to as emerging markets (EM). These regions are undergoing profound economic and social transformation that suggests they are poised for rapid growth over the coming decades.

The economic trajectory of these nations is clear: emerging markets are estimated to be responsible for approximately 60% of the world’s Gross Domestic Product (GDP) by 2026. This commanding projection of economic output stands in stark contrast to the current representation of emerging market equities in global portfolios. Currently, EM equities account for only about 13% of the total market capitalization of all international equities. This fundamental mismatch—where high expected economic output is vastly underrepresented in capital markets—creates a significant, long-term investment opportunity for global investors. As these economies evolve and mature, the size of their capital markets is expected to become more prominent, driving equity valuations higher over time.

Adding further conviction to this outlook is the demographic profile of emerging markets. These regions harbor a youthful and rapidly expanding population, often termed the “demographic dividend.” An estimated 77% of the world’s “Gen Z” cohort resides in emerging markets. This concentration of young, digitally native individuals suggests future growth fueled by increased consumption, productivity, and technological adoption, providing a robust engine for sustainable, long-term equity returns.

Key Investment Considerations for EM ETFs (Risk Overview)

While the growth potential is compelling, investment in emerging and frontier markets necessitates navigating unique and magnified risks. Compared to developed markets, emerging markets exhibit greater exposure to political instability, regulatory shifts, economic volatility, currency exchange rate fluctuations, and lower liquidity. Less developed legal, tax, and accounting systems also contribute to higher custodial and operational risks.

Given these unique challenges, passive or systematic exposure via ETFs is often the most efficient and practical gateway for investors. However, successful portfolio construction demands a nuanced approach to ETF selection, moving beyond simple market-cap weighting to incorporate strategies that manage specific geographic concentrations and systematically target factors that tend to outperform in these less efficient markets.

The 9 High-Return Emerging Market ETFs You Should Own (The Essential List)

The selection criteria for these nine essential Emerging Market ETFs balance competitive historical performance (where available), ultra-low cost, strategic diversification mandates, and systematic factor-based strategies proven to capture alpha in developing economies.

The 9 Essential Emerging Market ETFs:

1. AVEM (Avantis Emerging Markets Equity ETF)
2. SPEM (SPDR Portfolio Emerging Markets ETF)
3. VWO (Vanguard FTSE Emerging Markets ETF)
4. IEMG (iShares Core MSCI Emerging Markets ETF)
5. EMXC (iShares MSCI Emerging Markets ex China ETF)
6. ESGE (iShares ESG Aware MSCI EM ETF)
7. DFEM (Dimensional Emerging Markets Core Equity 2 ETF)
8. EEM (iShares MSCI Emerging Markets ETF)
9. EEMS (iShares MSCI Emerging Markets Small-Cap ETF)

Summary Table of 9 Essential Emerging Market ETFs

The table below provides a quick reference comparing key metrics, including the 5-year annualized total returns, expense ratios, and relative assets under management (AUM) for the high-performing and strategic core funds.

Summary Table of 9 Essential Emerging Market ETFs

Unlocking the Performance Drivers

1. AVEM – The Aggressive Outperformer (Avantis Emerging Markets Equity ETF)

The Avantis Emerging Markets Equity ETF (AVEM) stands out as the highest-performing ETF on this list, boasting an exceptional 5-year annualized total return of 10.77%. Launched in late 2019, AVEM has rapidly accumulated assets, reaching approximately $13.6 billion in AUM. The fund is benchmarked against the MSCI Emerging Markets IMI Index.

AVEM’s superior performance is rooted in its active, factor-based methodology. Avantis employs a systematic approach focused on identifying “structural growth at a reasonable price” (S-GARP) companies. This method systematically selects stocks with specific quality and value characteristics, a strategy designed to perform well in emerging markets where assets are often mispriced due to informational or governance deficiencies. The key takeaway from AVEM’s metrics is that its significant outperformance—generating approximately 400 basis points of alpha over the 5-year period compared to broad-market peers like EEM (6.34%) —justifies its moderate expense ratio of 0.33%. In inefficient emerging markets, systematic factor exposure often allows a fund to overcome the fee drag and deliver higher net returns than pure market-cap-weighted strategies.

2. SPEM – Max Value, Minimum Cost (SPDR Portfolio Emerging Markets ETF)

The SPDR Portfolio Emerging Markets ETF (SPEM) is a formidable competitor in the low-cost core category. It delivered an 8.13% 5-year annualized return. Crucially, SPEM shares the lowest expense ratio in the industry at just 0.07% , matching the cost of the Vanguard giant (VWO).

For the ultra-cost-sensitive investor, SPEM’s historical data shows it has been a marginally better choice, achieving a higher 5-year return than VWO (8.13% versus 7.75%). This subtle but important difference, despite identical fees, underscores the critical role of the underlying index selection, even among passive vehicles. The index tracked by SPEM likely provided a more favorable sector or geographical allocation during this specific period compared to the FTSE index used by VWO.

3. VWO – The Low-Cost Titan (Vanguard FTSE Emerging Markets ETF)

The Vanguard FTSE Emerging Markets ETF (VWO) is positioned as the definitive core holding for emerging market exposure due to its colossal scale and cost efficiency. With an AUM of approximately $102.9 billion , VWO is the market leader in institutional adoption and liquidity. It maintains the industry-low expense ratio of 0.07% and has produced a strong 5-year return of 7.75%.

However, VWO’s structure introduces a significant geopolitical concentration risk. The fund is heavily allocated to China, which makes up 29.7% of its country allocation, followed by India (16.4%), Brazil (3.9%), and Saudi Arabia (3.5%). The near 30% weighting in China means that VWO’s performance is intrinsically tethered to Beijing’s volatile regulatory environment and economic policy stability. For investors seeking true global diversification and prudent risk management, this high concentration acts as a structural risk, necessitating the consideration of complementary strategies, such as funds that explicitly exclude China, to effectively manage systematic exposure to this single major economy.

4. IEMG – Core Diversification (iShares Core MSCI Emerging Markets ETF)

The iShares Core MSCI Emerging Markets ETF (IEMG) is another core passive option, delivering a 5-year return of 7.55%. The fund is massive, with AUM exceeding $109 billion , and has a highly competitive expense ratio, estimated at 0.09%.

IEMG’s strategic difference lies in its mandate: it tracks the MSCI EM IMI (Investable Market Index), which includes exposure to large-, mid-, and, crucially, small-capitalization emerging market stocks. While VWO and SPEM focus primarily on large and mid-caps, IEMG’s inclusion of small-cap companies captures the potential long-term small-cap premium within a core, low-cost index structure. This total market approach provides more comprehensive coverage of the emerging market universe and avoids the high expense ratios (up to 0.73%) charged by dedicated small-cap funds like EEMS.

5. EMXC – Strategically Excluding China (iShares MSCI Emerging Markets ex China ETF)

The iShares MSCI Emerging Markets ex China ETF (EMXC) tracks an index composed of large- and mid-capitalization emerging market equities, specifically excluding China.

EMXC is not a performance-driven fund in the traditional sense, but a crucial tactical tool for risk management. In recent years, geopolitical tensions, trade protectionism, and regulatory uncertainty in China have driven institutional investors to treat the country as a unique, non-diversifying asset class. EMXC addresses the heavy China concentration observed in traditional benchmarks like VWO. Its rising popularity, noted by significant year-to-date inflows in 2025 , demonstrates a macro trend toward decoupling China exposure from the rest of the emerging market investment universe. By shifting weight to other economies—notably India, Taiwan, and Brazil—EMXC allows investors to maintain access to emerging market growth while mitigating the systemic risks associated with the US-China relationship and Chinese domestic policy.

6. ESGE – Sustainable Global Growth (iShares ESG Aware MSCI EM ETF)

The iShares ESG Aware MSCI EM ETF (ESGE) targets large- and mid-cap emerging market equities with positive Environmental, Social, and Governance (ESG) characteristics. The fund aims to provide a risk and return profile similar to the broad market index while achieving superior ESG metrics.

ESGE has demonstrated robust recent performance, with a year-to-date return of 33.0% , alongside a 5-year NAV return of 6.56%. This strong showing indicates that applying ESG screening does not necessarily detract from returns in emerging markets; rather, it often serves as an essential quality filter. In developing economies, poor governance (the ‘G’ component of ESG) is a significant predictor of corporate risk and operational headwinds. By systematically excluding companies with unfavorable ESG scores, ESGE tilts the portfolio toward structurally sounder, more resilient businesses, which has been rewarded by the market in recent cycles.

7. DFEM – Core Exposure, Dimensional Edge (Dimensional Emerging Markets Core Equity 2 ETF)

The Dimensional Emerging Markets Core Equity 2 ETF (DFEM), launched in April 2022 , utilizes a highly systematic, research-driven methodology characteristic of Dimensional Funds. Its objective is long-term capital appreciation by purchasing a broad and diverse group of securities associated with emerging markets.

A key differentiating feature of DFEM is its flexibility to include investments in frontier markets—countries in an earlier stage of development than traditional emerging markets. Frontier markets, while less liquid and often more volatile, offer potentially greater structural growth as they accelerate modernization. DFEM acts as a sophisticated tool for accessing this highly inefficient segment of the global equity market, suitable for investors with a very long time horizon who can tolerate increased volatility in pursuit of the potentially amplified returns offered by these early-stage economies.

8. EEM – The Liquidity Leader (iShares MSCI Emerging Markets ETF)

The iShares MSCI Emerging Markets ETF (EEM) is one of the oldest EM ETFs, established in 2003. It carries a 5-year return of 6.34%. EEM is characterized by a significantly high expense ratio of 0.72% , making it prohibitively expensive for long-term, buy-and-hold investors when compared to peers like VWO or SPEM (both 0.07%).

The primary relevance of EEM is purely transactional. Despite its cost and lower historical returns, EEM maintains its prominence as the single most liquid and tradable EM ETF, supported by a deep and active options market. Its high cost is effectively a premium paid by institutional traders, hedgers, and short-term speculators who prioritize transactional efficiency and depth of liquidity over low expense ratios and long-term accumulation. Investors focused on asset accumulation should generally avoid EEM due to the high expense ratio.

9. EEMS – High-Octane Small-Cap Bets (iShares MSCI Emerging Markets Small-Cap ETF)

The iShares MSCI Emerging Markets Small-Cap ETF (EEMS) provides dedicated exposure to the small-cap segment of developing nations. Historically, smaller capitalization companies often outperform their large-cap counterparts over extensive periods, driven by higher growth potential and greater market inefficiency.

EEMS carries the highest expense ratio on this list, at 0.73%. This elevated cost reflects the underlying operational complexity and higher trading costs associated with managing a portfolio of less liquid, smaller companies scattered across multiple emerging economies. This fund is essential for investors looking to explicitly capture the size factor premium within their portfolio. The high expense ratio is only justified if the realized alpha generated by the small-cap factor premium consistently exceeds the fund’s operating cost over the investor’s long-term holding period.

Strategic Investor Checklist: Comparing the Crucial Metrics

Performance vs. Cost: Finding Your Sweet Spot

The core decision facing an emerging market investor involves balancing the lowest possible cost (passive beta) against the potential for alpha generated by systematic factor-based strategies (active/smart beta). The data reveals a clear trade-off between the ultra-cheap indexing options and the factor-tilted funds.

For instance, an investor must determine if the nearly 400 basis points of historical outperformance delivered by the factor-driven AVEM (10.77% 5-year return) justifies paying its 0.33% expense ratio, when passive alternatives like SPEM (8.13%) and VWO (7.75%) offer exposure at 0.07%. This calculation is particularly relevant in emerging markets, where significant inefficiencies mean that systematic security selection strategies often retain performance advantages even after fees are deducted. SPEM represents the most efficient passive choice, delivering the highest return among the ultra-low-cost alternatives.

Table: Performance and Cost Efficiency

This table directly contrasts the returns funds generate relative to their costs, highlighting efficient alpha generation when compared against the category’s largest core fund, VWO.

Performance and Cost Efficiency

The Role of Size, Liquidity, and Benchmarking

The size of an ETF, measured by its AUM, is a crucial metric for ensuring favorable trading conditions. The multi-billion dollar scales of VWO ($102.9 billion) and IEMG (over $109 billion) ensure robust market liquidity, which translates directly into tighter bid-ask spreads for investors. This minimizes transaction costs, especially for large institutional trades.

The contrasting liquidity profiles of EEM and VWO highlight different investor objectives. VWO appeals to long-term investors focused on minimizing holding costs. Conversely, EEM’s high trading volume and deep options market make it the preferred vehicle for institutional investors engaging in tactical short-term moves or complex hedging strategies, a preference for which they are willing to accept the significant drag of a 0.72% expense ratio.

V. Risk Mitigation and Portfolio Construction

Mitigating the 4 Critical Emerging Market Risks

Emerging market exposure is inseparable from elevated risk. Effective mitigation relies heavily on diversification and robust issuer selection.

1. Political and Economic Risk: Political instability, social volatility, and less stable economic systems are magnified in EM. This is evident in major country weightings; VWO’s nearly 30% concentration in China means that geopolitical events tied to Beijing can disproportionately affect global EM returns. Strategic funds like EMXC, which specifically exclude China, allow investors to actively reduce this concentrated single-country political exposure.
2. Custodial and Operational Risk: The risk stemming from less developed legal and regulatory frameworks, along with greater custodial challenges, is inherent in developing markets. This risk is best managed by relying exclusively on ETFs issued by major, highly regulated global providers (Vanguard, iShares, SPDR, Avantis, Dimensional) that possess the operational scale and expertise to navigate these complex markets.
3. The Critical Tax Caveat: Emerging market ETFs face unique tax inefficiency challenges, particularly for investors holding them in taxable accounts. While ETFs generally benefit from the tax-efficient “in-kind” redemption process, high rates of investor redemption in volatile EM funds can disrupt this mechanism. When liquidity is tight, the ETF may be forced to sell underlying securities to raise the cash required for redemptions, rather than delivering stock. This forced asset sale constitutes a taxable event, potentially subjecting investors to unexpected capital gains distributions.
4. Derivatives and Leverage: While most funds listed here are standard equity index trackers, any EM exchange-traded product (ETP) or ETF that uses derivatives, leverage, or complex investment strategies is subject to additional risks. Such funds, including leveraged/inverse ETFs, have historically proven to be relatively tax-inefficient, often resulting in significant capital gain distributions because the underlying derivatives (swaps and futures) cannot be redeemed in-kind.

The Core-Satellite Approach to EM Investing

Given the dual needs for low-cost, broad diversification and tactical management of risks and factors, a core-satellite construction model is recommended for EM equity exposure.

• Core Allocation (70%–80%): The vast majority of assets should be placed in ultra-low-cost, broad-market funds that provide diversified beta exposure, such as VWO, SPEM, or IEMG. These provide minimum tracking error and maximum cost efficiency.
• Satellite Allocation (20%–30%): The remaining allocation should be used to customize risk and target higher potential returns through specialized funds. Examples include AVEM for systematic factor-based alpha, EMXC for geopolitical risk management (controlling China exposure), and EEMS or DFEM for capturing the small-cap or frontier market premium.

Frequently Asked Questions (FAQ)

Q1: Are Emerging Market ETFs More Volatile Than Developed Market ETFs?

Yes, emerging market stocks are substantially more volatile and less liquid than developed market equities. The underlying risks—including political, social, and economic instability—are magnified in developing nations. Furthermore, research indicates that investor flows into dedicated emerging market ETFs are generally more sensitive to changes in global financial conditions than flows into EM mutual funds. This increased sensitivity of capital flows can amplify market swings and contribute to higher overall volatility.

Q2: What is the primary difference between VWO and EEM, given EEM’s high expense ratio?

The difference lies entirely in objective and structure. VWO (Vanguard) is designed as a long-term core holding with an ultra-low expense ratio (0.07%) and focuses on maximizing net returns for asset accumulators. EEM (iShares) carries a drag of 0.72% and is inefficient for long-term holding. EEM’s high cost is maintained because it serves as the most liquid, institutional trading vehicle, offering extensive options markets and the tightest transactional efficiency required for short-term speculation, hedging, and sophisticated market-making strategies.

Q3: Should I invest in an Emerging Market Ex-China ETF (EMXC)?

The strategic necessity of EMXC is tied directly to managing country concentration risk. Traditional core funds like VWO allocate nearly 30% of their holdings to China. The iShares MSCI Emerging Markets ex China ETF (EMXC) offers a critical tool for investors who believe their total China exposure is too high or who wish to invest in the rest of the emerging world separately to better control political and regulatory risk. Growing institutional demand for ex-China strategies confirms this is an increasingly prudent approach to portfolio construction.

Q4: Are there specific tax considerations for Emerging Market ETFs?

Yes. Holding EM ETFs in a taxable brokerage account exposes investors to a specific tax risk related to capital gains distributions. Due to periods of heavy redemptions combined with low market liquidity, emerging market ETFs may be compelled to sell underlying foreign securities rather than utilizing the standard, tax-efficient “in-kind” redemption process. This forced sale causes a taxable event, subjecting investors to capital gains. It is highly recommended that volatile assets, such as emerging market equities, be held in tax-deferred accounts (e.g., IRAs or employer-sponsored retirement plans) to avoid these potential tax liabilities.

Q5: How Do Factor-Based ETFs Like AVEM Generate Higher Returns?

AVEM and similar factor-based funds employ a systematic, rule-based approach to select stocks that exhibit persistent factors known to yield excess returns, such as value or quality (S-GARP). In the relatively inefficient emerging markets, where pricing errors and information asymmetries are common, these systematic screening methodologies identify and tilt toward mispriced stocks. This process can generate performance (alpha) that is sufficient to absorb the moderate expense ratio (0.33% for AVEM) and still deliver higher net returns than a pure market-cap-weighted benchmark.

Q6: What is the risk associated with funds that hold derivatives or leveraged positions?

ETPs that use complex investment strategies involving derivatives (such as swaps and futures) or leverage are subject to additional layers of risk. These strategies, often used by leveraged or inverse funds, introduce higher counterparty risk and volatility. Furthermore, they are often tax-inefficient because derivatives cannot be delivered “in-kind” during redemptions, resulting in significant capital gain distributions to shareholders.