Emerging Markets: When Are They Worth It?

Using 24 years of data, we show that emerging market equities are a worthy addition to a U.S. investor's portfolio of developed market equities. Specifically, portfolio returns increased by approximately 1.5 percentage points a year when emerging country equities were included in the investment set. When we considered U.S. Federal Reserve monetary policy, however, we found that the benefits of investing in emerging markets accrued almost exclusively during periods of restrictive U.S. monetary policy. During periods of expansive U.S. monetary policy, the benefits to a U.S. investor of holding emerging market equities were trivial. An implication of our findings is that evaluating monetary conditions is a necessary prerequisite to identifying an optimal allocation of assets to international equities.