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Are Mutual Funds Ignoring Their Mandates?

When is an emerging market fund not 100 percent in emerging markets? When Morningstar uses its own definition for emerging markets.

My Right Financial Plan co-author Tiya Lim received a question from a client regarding one of her mutual funds. After reviewing her retirement report, this client called to inquire why her DFA Emerging Markets Core Equity Portfolio (DFCEX) had more than 27 percent of its holdings in developed markets. After a bit of investigating, this is what we discovered.

Her retirement report was generated using Morningstar data. Morningstar counts Taiwan and South Korea as developed countries. On the other hand, MSCI (which manages the widely used MSCI indices) doesn't consider Taiwan and South Korea as developed countries. DFA and Vanguard also considers them emerging market countries.

So by using Morningstar as the source for analysis, DFA, Vanguard and any other emerging market fund that using MSCI as a benchmark will appear to have more than 25 percent of its holdings in developed markets. The following is from Morningstar and shows the country breakdown for DFCEX.


In fact, it appears the majority of emerging market funds disagree with Morningstar's definition, since Morningstar indicates that the category average for emerging market funds is also more than 25 percent in developed markets.

It's understandable to be nervous that your funds may not be getting the exposure you're expecting, especially if that exposure is built into your plan. Certainly, you should be concerned (if not outraged) if, for example, a fund you were counting on to give you equity exposure was heavily invested in bonds.

In this case, it was simply an issue of misclassification. Still, it's important to make sure your funds are giving you the market exposures you desire.

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