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Emerging Markets Funds are arguably one of the hottest mutual funds segments today. For the most part, people who are looking for equity exposure and are fed up with domestic equity funds and their performance will turn to the emerging markets as a way to increase their portfolio’s performance while at the same time avoiding some of the other popular options (ahem, Bond Funds) that seem to have attracted investors.

Emerging Markets have also been where investors have seen some hefty returns. The Virtus Emerging Markets Opportunities Fund (HEMZX) has seen an impressive 21.3% YTD return. Its 5 year annualized return is 13.7%. Not bad. But if we take a closer look at this emerging markets fund, is it really something for you and your portfolio?

An Emerging Markets Fund That Likes India

One of the first questions an investor should ask before investing in a mutual fund like this one is whether or not he or she agrees with the fund’s geographic weighting. In this case, that weighting is fairly heavy on the Asia front with 51.8% of its assets invested there. On the Latin America front, just 29.5% of assets are invested there.

This begs the question, what parts of emerging Asia does this fund see as particularly attractive or lucrative? Of its Top 25 holdings, 13 of them can be found in Asia, with 5 of these (or 15.4%) invested in India. For investors who believe that India offers tremendous opportunity thanks to a growing and educated middle class, then this kind of weighting is great.

However, for people who are more bullish on China, they should note that just 4 China securities found their way on the list of Top 25 with total exposure of 6.2%, less than half of the exposure to India.

Is India Worth It?

Taking such a bullish stance on India is definitely noteworthy especially when you consider that this fund’s two top holdings are based in India. These holdings are also in the financial services sector. Those stocks are HDFC Bank, Ltd which has had a YTD return of 45% and Housing Development Finance Corporation, Ltd which has had a YTD return of -71.5%. The fund continues to add to both positions.

That financial services sector is also worth mentioning since this top performing emerging markets fund is underweight in financials compared to its peers. We believe this could actually be a big negative for the fund given that so many financial services firms stand to benefit from stronger economics in India and other emerging markets.

On the other hand, playing shy with emerging markets financial services firms can also be a big plus; this sector is one that many competing funds find attractive and that kind of popularity is always a red flag. Look at its Number 2 Holding, Housing Development Finance Corporation which robbed this fund of 71.5%. So while some firms perform and will continue to perform well, others like the Housing Development Finance Corporation (which is a related party to HDFC Bank, it turns out) will suffer… and we are not just talking about sub-10% figures here. In fact, almost all returns, negative or positive, are in double-digit territory.

Where this top performing mutual fund has taken a clear overweight position has been in the Consumer Goods sector. Not only is this sector the fund’s largest play, representing roughly 1/3 of total assets, but it is overweight compared to its peers to the tune of three (3) times!

The underlying securities in this sector have done well for the fund. It seems that the most attractive consumer goods stocks are those in Brazil — Souza Cruz S.A. at 3.92% of holdings returned 52.8% YTD; AmBev ADR at 3.5% of holdings returned 20.3% representing 7.4% of total holdings collectively. Its China Consumer Goods play, Hengan International Group Co. Ltd., at 1.5% of holdings has returned a little more than 26% but the fund has reduced its exposure by more than 31%.

Who Should Buy This Emerging Markets Fund

The Virtus Emerging Markets Opportunities Fund tells us a few things. It likes Consumer Goods, particularly stocks that are based out of Brazil. It is cautious on China vis-a-vis India (in fact, almost all of its Top 25 holdings in China have been reduced). Financial Services, while we see there being great potential for returns here (another Top 25 financial services firm not related to HDFC is based out of Mexico, Banco Compartamos, S.A., Institucion De Banca Multiple, has returned 24% on a YTD basis), is moderated here, possibly for good reason.

As a specialty component to your asset mix, this emerging markets fund should represent single-digit exposure for those who are more bullish on India than China (like us) and who feel that consumer goods will see better profits than financial services firms (not such much like us).

Would we buy this fund? Probably not, based solely on asset mix. But those performance numbers are extremely tough to argue with. YTD at 21.3%, 1-year at 30.8%, 5-year and 10-year at 13.7%. And of course you have its Morningstar rankings that are always impressive.

We are allowed to be wrong, and this might very well be one of those great emerging markets funds that we are wrong about by sitting this one out.