How to Reenter Emerging Markets with ETFs

Recency bias has a powerful effect on how investors reassess their portfolios. For many Canadian investors, that has often meant an overweighting to U.S. equities at the expense of broader international exposure, including both developed and emerging markets.

Part of this preference comes from experience. Many younger investors never lived through the so‑called “lost decade” from the early 2000s through the global financial crisis, when the S&P 500 delivered negative annual returns, according to Dimensional Fund Advisors. During that period, other segments such as U.S. small caps, value stocks, international equities and emerging markets produced significantly stronger returns.

By contrast, the 2010s and the post‑COVID stimulus era were dominated by U.S. large‑cap growth and mega‑cap technology firms, which led to sustained U.S. outperformance and shaped how many people think about diversification today.

Recently, emerging markets have begun to attract renewed attention after a long stretch of underperformance. For example, over 2024 and 2025 the iShares Core MSCI Emerging Markets IMI Index ETF (XEC) returned 25.34% in Canadian dollars, while the iShares Core S&P 500 Index ETF (XUS) returned 12.06% over the same period. Such performance gaps naturally prompt investors to reconsider allocations—recent returns are a strong motivator for rebalancing.

Emerging markets are not new to diversified portfolios; many all‑in‑one or asset‑allocation ETFs already include exposure to them. If you build your own portfolio, however, choosing an “emerging markets” fund requires closer scrutiny. ETFs with similar names can vary widely in construction, holdings, country exposure and tax treatment—differences that materially affect risk and return. Below are key considerations for Canadian investors.

What counts as an emerging market isn’t always clear

In broad terms, emerging markets sit between developing and fully developed economies: they often offer higher growth potential, expanding consumer markets and improving capital markets, but also greater political, currency and governance risk.

Where variation appears is in how index providers classify specific countries. Different benchmark methodologies can change the composition of an ETF and the industries and companies you ultimately own.

For example, as of April 2026, XEC’s country exposure includes Taiwan, China, South Korea, India, Brazil, South Africa, Saudi Arabia, Mexico, Malaysia, the United Arab Emirates, Thailand and Poland. By comparison, the Vanguard FTSE Emerging Markets All Cap Index ETF (VEE) lists China, Taiwan, India, Brazil, South Africa, Saudi Arabia, Mexico, Malaysia, Thailand and the United Arab Emirates among its top exposures—but South Korea is absent.

The reason is index methodology: MSCI (which underpins XEC) classifies South Korea as an emerging market, while FTSE (which VEE follows) classifies it as developed. That difference matters: South Korea represents about 17.19% of XEC’s portfolio and includes major technology names such as Samsung Electronics and SK Hynix. In practice, the “emerging markets” label alone does not convey the full country or sector exposure; you must examine index rules and country weights.

Investors often underestimate emerging‑market volatility

Another common oversight is underestimating the volatility of emerging markets. Many recent investors have experienced sharp but relatively short market shocks—such as the rapid rebound after the March 2020 COVID crash—so they may not fully appreciate how prolonged drawdowns can be.

Volatility can be quantified by standard deviation, which measures how much returns vary around their average. Using U.S.‑listed iShares ETFs for consistency, the difference is visible: the S&P 500 ETF IVV has a three‑year standard deviation of 12.06%, while the broader emerging markets ETF IEMG registers 13.86%. While a percentage point or two may seem small, in dollar terms and for larger portfolios that difference can mean noticeably bigger day‑to‑day swings.

Factor‑based or minimum‑volatility strategies aim to reduce these swings. For example, the iShares MSCI Emerging Markets Min Vol Factor ETF (EEMV) shows a lower three‑year standard deviation of 9.67%, reflecting a more defensive approach. Still, investors should expect greater variability from emerging markets due to several structural factors:

1. Many emerging economies depend heavily on commodities or exports, making them sensitive to global demand cycles.
2. Regulatory and policy shifts can be abrupt, adding political and governance risk.
3. Currency fluctuations introduce additional uncertainty for Canadian investors measuring returns in Canadian dollars.

None of this makes emerging markets unsuitable—only that investors should accept a bumpier ride and factor that volatility into allocation decisions.

The hidden drag of double foreign withholding taxes

A less obvious cost of some Canadian emerging‑market ETFs is an extra layer of foreign withholding tax when the ETF uses a U.S.‑listed fund as an intermediary. That structure can create a “tax on tax” effect that reduces dividend income and total returns.

Consider the iShares MSCI Emerging Markets Index ETF (XEM), which uses a fund‑of‑funds approach and holds the U.S.‑listed iShares MSCI Emerging Markets ETF (EEM) rather than owning the underlying stocks directly. Dividends from companies in emerging markets face local withholding taxes before they reach EEM; when EEM distributes dividends up to XEM a second layer of U.S. withholding tax—commonly 15%—is applied.

The result is lower income for Canadian investors: XEM’s trailing 12‑month yield is 1.67% compared with 2.16% for EEM. Combined with XEM’s 0.83% expense ratio, this structural tax and fee drag helps explain why XEM’s net asset value return since inception has been about 6.7% annually versus 7.68% for the underlying index—a near 1% performance gap.

To reduce this drag, investors have two practical approaches. One is to choose Canadian‑listed emerging‑market ETFs that hold the underlying securities directly rather than through a U.S. ETF, eliminating the second layer of withholding tax. The other is to hold U.S.‑listed ETFs such as EEM inside an RRSP, where the Canada‑U.S. tax treaty typically exempts the 15% U.S. withholding tax on dividends.

Emerging markets are viable investments if you are careful

Emerging markets can play an important role in a diversified, long‑term portfolio—particularly for investors seeking exposure beyond North America. The purpose of this discussion is not to discourage investment but to highlight that emerging‑market ETFs carry additional complexities.

Key considerations include index construction and country definitions, higher historical volatility, and tax and fee structures. These factors influence performance and risk in ways that may not be apparent from a fund’s name alone. Before allocating capital, understand what you own: review the index methodology, country and sector weights, volatility profile, expenses, and the fund’s tax treatment. Doing so reduces the chance of unwelcome surprises and helps ensure each holding serves the role you intend in your overall portfolio.

Read more about investing with ETFs:

• Do you need market‑neutral ETFs in your portfolio?
• Best fixed‑income ETFs for Canadian investors 2026
• Pitfalls to avoid when investing in sector ETFs
• Why a cautious allocation can work for retirees