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Canadian investors are notorious for their home bias, preferring to put their savings into domestic bank and utility stocks rather than prospects further afield. But with emerging markets driving an estimated two-thirds of the world’s economic growth – while also boasting younger demographics and carrying significantly less debt than most developed nations – the sector merits closer long-term attention, regardless of the United States’ volatile international trade policies.

The term “emerging markets” lumps together diverse regions – from South America to Eastern Europe and from Africa to distant Asia – whose countries have little in common other than their tremendous growth potential. They differ in an enormous number of ways, including their political structures, the condition of their banking sectors, their levels of foreign debt and their exposure to commodity prices.

Figuring out where to invest wisely in such a large space can be daunting, and the cost of different strategies varies significantly. One route is to rely on mutual funds that try to outperform the broad market with stock-picking teams composed of global specialists with local knowledge. Brand names such as Fidelity, Templeton, CI Investments and Sun Life use this model, and their emerging-market funds rate highly in Morningstar rankings.

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CI Signature Emerging Markets and Sun Life Emerging Markets have posted three-year returns (measured after fees) close to 7 per cent and have management expense ratios (MERs) just over 2.5 per cent. Fidelity Emerging Markets returned 8.4 per cent in that period and has an MER of 2.3 per cent.

A second route into emerging markets is to buy an ETF that tracks a country’s main stock-market index, such as India’s NIFTY 50, or an index covering numerous countries, such as BlackRock’s iShares MSCI Emerging Markets Index. The iShares fund has a three-year return of 5.37 per cent and an MER of just 0.78 per cent.

The fee difference between actively managed mutual funds and passive ETFs is significant, but “it’s important investors don’t adopt a low-cost obsession,” says Karl Cheong, head of ETFs at FT Portfolios Canada, an investment-fund manager in Toronto.

Actively managed mutual funds, he points out, can benefit from the fact that emerging markets are less liquid and therefore less efficient than developed markets. This difference gives savvy stock pickers in emerging markets an even stronger shot at beating the overall market than they might have in North America.

In response to the U.S. trade war with China, for instance, mutual fund portfolio managers can reduce exposure to Chinese companies hurt by new tariffs and look for stocks of promising businesses in Vietnam that might benefit from the shifting trade patterns. Investors holding a passive ETF tied to a broad index, however, don’t have that flexibility.

But building an emerging-markets portfolio using mutual funds presents two key challenges, Mr. Cheong says. First, the fund manager has to beat the overall market index every year. And second, the investor has to pick the winning mutual fund from a long list of offerings.

For the average investor, the lower cost of ETFs, together with the broad-based stock allocation they offer, may wash away, over the long term, the advantage of local market intelligence that leading mutual fund companies enjoy, Mr. Cheong says.

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In the past few years, a third strategy has opened up for retail investors interested in emerging markets. It involves tapping into an expanding base of ETFs that offer even broader diversification.

A proliferation of new ETFs, listed on U.S. and Canadian exchanges, means investors can buy into specific sectors – such as Chinese internet stocks or Indian infrastructure plays – or choose funds based on stock valuations, volatility levels or dividend yields. David Kletz, a portfolio manager at Forstrong Global Asset Management Inc., describes these as “low-cost funds with an active tilt.”

The NIFTY 50, for instance, can now be complemented with an Indian small-cap ETF, giving investors the chance to buy into companies that are still largely unknown in Canada – some of which could grow into India’s next big corporate stars.

Ten years ago, it was difficult for ETFs to distinguish themselves from the main benchmark indices in emerging markets. That’s changed today with these innovative products. At the same time, rising competition among funds keeps driving fees lower, with several emerging-market ETFs listed on U.S. exchanges charging less than 0.15 per cent.

The sizeable premium in fees charged by mutual funds presents a “hurdle that’s difficult to clear over the long term,” Mr. Kletz says.

Of course, as the variety of ETFs in emerging markets increases, so does the complexity of choice. Firms like FT Portfolios and Forstrong Global Asset Management provide tools and insights to advise the advisers, which means the best way to construct a portfolio of low-cost, passive emerging-market funds might be to have them actively managed by a professional financial adviser in Canada.

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“There are more and more ways to slice this universe,” Mr. Kletz says.

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