When reviewing equity market returns through mid-June, it is certainly understandable that investors might question any allocation they have made to Emerging Market (EM) stocks. As of June 14th, EM stocks, as measured by the MSCI EM Index, have returned a -8.31% for 2013. Their 3-year cumulative return through June 14th was 11.56%. Compare this to the S&P 500 Index return of 15.21% and 59.23% for the same time periods. Even developed international stocks, as measured by the MSCI EAFE Index, have fared better despite the fact that several of the European countries represented in this group are in a recession. The MSCI EAFE was up 7.59% through June 14th and has a three-year cumulative return of 34.69%.

So why have emerging market stocks lagged the performance of developed markets? One reason is that many emerging market economies are tied closely to the export of commodities. Given the global economic slowdown, commodity demand and prices have suffered. Emerging economies are also dependent upon consumer consumption in more developed countries. These consumers, particularly in Western Europe, have lost not only a tremendous number of jobs but also their appetites for non-discretionary purchases. Individually, Brazil, Russia, India and China (the BRICs) have certainly contributed to the sour returns. Together these four EM countries represent approximately 43% of the MSCI EM Index, and each is currently struggling with their own specific challenges. For China, it is slow growth. Brazil is facing high inflation which curbs consumer spending. India has a large fiscal deficit, and Russia depends upon commodity exports.

Granted, the recent returns (short-term) beg the question, "Why take the risk?"

According to the IMF (International Monetary Fund), emerging market countries account for 51% of global GDP based on purchasing power parity. This dwarfs the US share of only 19%. Emerging market economies also continue to increase their share of the global equity market. At the end of 2012, emerging and frontier markets accounted for 26% of the world's market capitalization.[1] Emerging market countries offer growth opportunities due to their economic position and demographic characteristics. It is no secret that many of the emerging market countries have young and growing populations that will contribute to future economic output and, increasingly, to consumer consumption. Additionally, the financial strength of government balance sheets, coupled with supportive policies, are expected to allow emerging markets' GDP growth to accelerate at faster rates relative to the US and other developed economies.

There is no doubt that investing in emerging markets equity can increase the volatility of a portfolio due to its higher risk/reward profile. As a long-term investment, however, we view emerging markets as a critical component of future portfolio growth for investors. When building an emerging markets position, we recommend seeking diversification beyond the obvious players. Don't throw out the BRIC's, but look for opportunities to benefit from the growth of the next wave of emerging economies - those with the population and dynamics to contribute to global growth over the next decade and beyond.

From a long-term perspective, perhaps the question really is, "What is the risk of ignoring EM exposure?"

[1] December 31, 2012 Market Capitalization of listed companies in US$ l Source: The World Bank