What’s the worst that could happen?

At Fred’s funeral, the minister confessed that he didn’t know Fred very well, and asked if some of the few people in the crowd could say something nice about it. No one moved. “Surely there must be someone here,” he pleaded, “that can say something nice about this man?”

Finally, a man in the back stood up. “His brother was worse,” he said.

The past few years, it’s been tough having anything good to say about emerging markets funds. TheĀ Vanguard Emerging Markets Stock Index fund, a reasonably proxy for emerging markets, has fallen 12.7%. vs. a 3% loss the Standard and Poor’s 500 stock index with dividends reinvested.

The Istanbul skyline.
The Istanbul skyline.

The long-term record isn’t great, either. Vanguard’s emerging markets fund has gained an average 5.9% a year the past 20 years, vs. an average 8.5% a year for the S&P 500. (Average annual gains mask the difference in long-term underperformance. A $10,000 investment in the S&P 500 would be $51,120 now. The same in the Vanguard Emerging Markets fund would be $31,472 — a $19,649 difference.)

That underperformance came at considerable damage to your psyche. One way to measure that is to look at a fund’s maximum drawdown — that is, the performance of the fund from top to bottom. In essence, it measures the experience of the hapless investor who bought at the top and sold at the bottom — the Joe Btfsplks of the investing world.

During the S&P 500’s worst peak-to-trough performance over the past 20 years, the index shed a harrowing 51%. How could things have gotten worse? You could have added an emerging markets fund to your portfolio. The Vanguard Emerging Markets Stock Index fund plunged 62.7% the same period. Those drops were, of course, during the financial crisis of 2007-2009.

But emerging markets routinely suffer above-average losses, because that’s the nature of markets are less liquid and transparent than those in developed markets. Let’s look at the past five years, conveniently overlooking the financial meltdown of 2007-2009. The worst drawdown for emerging markets has been 27.2%, vs. 16.3% for the S&P 500.

At least in theory, you should get more return for taking greater risk. But somewhere in that theory is a line beyond which the risk isn’t worth taking. (If there weren’t, then your best long-term investment would be lottery tickets.) Although emerging markets are cheap now, and may be interesting as an intermediate-term speculation, it’s hard to recommend them for long-term growth.

 

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