A practical guide to developing-country equity ETFs, covering classification differences, higher volatility, and key tax considerations for Canadian investors.
Advertisement
Photo by Wirestock on Freepik
There is nothing like recency bias to get investors rethinking their portfolios. For Canadian investors, that historically meant an overweight to U.S. equities, usually at the expense of international exposure, whether developed or emerging markets.
Advertisement
Advertisement
Part of this comes down to experience. Many younger investors did not invest through the so-called “lost decade,” from the early 2000s through the tail end of the global financial crisis. According to Dimensional Fund Advisors, the S&P 500 delivered negative annual returns over that stretch. In contrast, areas like U.S. small caps, value stocks, international equities, and emerging markets significantly outperformed.
From the turn of the decade through the post-COVID stimulus era, the opposite played out. U.S. equities, driven by mega-cap technology and growth companies, dominated global markets. That has shaped how many investors think about diversification today.
Now, after underperforming for more than a decade, emerging markets appear to be gaining some momentum again. Over 2024 and 2025, the iShares Core MSCI Emerging Markets IMI Index ETF (XEC) returned 25.34% in Canadian-dollar terms. Over the same period, the iShares Core S&P 500 Index ETF(XUS) returned 12.06%. That kind of performance gap naturally attracts attention. Nothing prompts investors to reassess their allocations quite like recent returns.
At the same time, emerging markets are not new. They have long been a core component of diversified portfolios. If you are invested in an asset-allocation ETF, you likely already have some exposure.
But if you are building your own portfolio, it is not as simple as picking a fund with “emerging markets” in the name. There are meaningful differences in how these ETFs are constructed, what they actually hold, and the risks they introduce. Here are some of the nuances Canadian investors should watch out for.
What counts as an emerging market isn’t always clear
At a high level, emerging markets are countries that sit between developing and fully developed economies. They tend to have faster growth potential, expanding middle classes, and improving capital markets, but also come with higher political, currency, and governance risks.
That general definition is widely accepted. Where things start to differ is in how index providers classify individual countries. You need to understand how the benchmark provider defines what qualifies as “emerging” versus “developed,” because those decisions directly affect what you end up owning.
Take the above mentioned XEC as an example. As of April 2026, its country exposure in descending order includes, but is not limited to, Taiwan, China, South Korea, India, Brazil, South Africa, Saudi Arabia, Mexico, Malaysia, the United Arab Emirates, Thailand, and Poland.
Article Continues Below Advertisement
Now compare that to the Vanguard FTSE Emerging Markets All Cap Index ETF (VEE). Its top exposures from largest to smallest include China, Taiwan, India, Brazil, South Africa, Saudi Arabia, Mexico, Malaysia, Thailand, and the United Arab Emirates.
Notice what is missing from VEE that is present in XEC: South Korea. The difference comes down to index methodology. MSCI, which underpins XEC, classifies South Korea as an emerging market. FTSE, which Vanguard follows, classifies it as a developed market.
As a result, South Korea makes up about 17.19% of XEC’s portfolio, with major holdings like Samsung Electronics and SK Hynix, while it is entirely absent from VEE. That is a meaningful shift in exposure, particularly given South Korea’s role in global technology supply chains. (Investors owning international developed-market ETFs will face a similar situation as well.)
There is no need to take a firm stance on whether South Korea should be considered developed or emerging. Even major index providers disagree. The key takeaway is that the label on the ETF does not tell the full story. You need to look under the hood at country weights and index rules to understand what you are actually buying.
Investors often underestimate emerging-market volatility
On the topic of newer investors, one observation worth making is that many may be overestimating their risk tolerance. Over the past several years, markets have experienced shocks, but many of them were either short-lived or quickly reversed.
The March 2020 COVID crash rebounded rapidly. The 2022 bear market was more drawn out, but still relatively shallow by historical standards, even if it felt worse due to bonds declining alongside stocks.
For many investors, especially those who started investing more recently, there has been limited exposure to prolonged drawdowns. That can shape expectations. It is not uncommon to see portfolios built around 100% equities under the assumption that markets will trend upward over time. While that is broadly true over long horizons, the path can be volatile, and those swings become more noticeable as portfolio values grow.
MoneySense is an award-winning magazine, helping Canadians navigate money matters since 1999. Our editorial team of trained journalists works closely with leading personal finance experts in Canada. To help you find the best financial products, we compare the offerings from over 12 major institutions, including banks, credit unions and card issuers. Learn more about our advertising and trusted partners.
One way to quantify this is through standard deviation, which measures how much returns tend to vary around their average. Higher standard deviation means larger and more frequent swings in value.
Advertisement
Advertisement
Using U.S.-listed iShares ETFs for consistency, the differences are clear. For example, IVV has a three-year standard deviation of 12.06%. By comparison, IEMG comes in higher at 13.86%. That gap may not look large in percentage terms, but in dollar terms it can be meaningful. As portfolio sizes increase, even small differences in volatility translate into larger day-to-day swings in value.
There are ways to manage this. Factor-based strategies, such as minimum volatility approaches, aim to reduce these fluctuations. For example, the iShares MSCI Emerging Markets Min Vol Factor ETF (EEMV) has a lower three-year standard deviation of 9.67%, reflecting a more defensive tilt.
Developing markets have historically been riskier, and it is important to understand what that looks like in practice before allocating capital. Several factors contribute to this:
Emerging market economies often rely more heavily on commodities or exports, which can make them sensitive to global demand cycles.
Regulatory environments can also be less stable, leading to abrupt policy changes or outright expropriation.
Foreign exchange fluctuations add another layer of uncertainty, especially for Canadian investors measuring returns in dollars.
All of this does not make emerging markets uninvestable. It simply means that the ride can be bumpier than in developed markets, and that is something investors should be prepared for going in.
The hidden drag of double foreign withholding taxes
The final piece investors should understand is that, depending on how an emerging market ETF is structured, there can be an additional layer of foreign withholding tax that quietly reduces returns. This issue is most common in Canadian ETFs that gain their international exposure through an underlying U.S.-listed ETF rather than holding stocks directly.
A good example is the iShares MSCI Emerging Markets Index ETF (XEM). This fund launched in June 2009 and tracks its benchmark using a fund-of-funds structure. Instead of holding emerging market stocks directly, its primary holding is the U.S.-listed iShares MSCI Emerging Markets ETF (EEM).
That structure introduces a second layer of foreign withholding tax. Here is how it works:
When companies in emerging markets pay dividends, local withholding taxes are applied before those payments even reach EEM.
Then, when EEM distributes those dividends up to XEM, a second layer of U.S. withholding tax, typically 15%, is applied.
What you end up with is effectively “tax on tax,” which reduces the income that ultimately reaches Canadian investors. XEM’s trailing 12-month yield is 1.67%, versus 2.16% for EEM.
Advertisement
Advertisement
Layer on XEM’s relatively high 0.83% expense ratio, and the impact becomes more noticeable. Since inception, XEM has delivered a 6.7% annualized return at net asset value, compared to 7.68% for its underlying index. That’s a nearly 1% performance gap.
To avoid this, investors have two practical options. The first is to screen for Canadian-listed emerging market ETFs that hold the underlying stocks directly rather than using a U.S. ETF as an intermediary. This eliminates the second layer of withholding tax and improves tax efficiency.
The second option, if you prefer U.S.-listed ETFs like EEM, is to hold them in a registered retirement savings plan (RRSP), where the 15% U.S. withholding tax on dividends is generally exempt thanks to the Canada-U.S. tax treaty.
Emerging markets are viable investments, if you are careful
Emerging markets are not something to avoid. If anything, they can play an important role in a diversified long-term portfolio, especially for investors looking beyond North America.
The point of this isn’t to dissuade investment. It’s to highlight that emerging-market ETFs come with an extra layer of complexity. Between index construction, country classification, higher volatility, and tax structure, what you think you’re buying is not always what you actually get.
Understanding those details up front helps you avoid the kind of surprises that often show up later, usually in the form of performance gaps, unexpected risk, or tax drag. It also saves you from having to ask after the fact why a particular ETF behaved differently than expected.
In short, know what you own, know how it is built, what it costs, and how it is taxed. Then make sure it fits the role you want it to play in your investment portfolio.
Newsletter
Get free MoneySense financial tips, news & advice in your inbox.
Tony Dong has been published on USA Today, U.S. News & World Report, TheStreet and more. He is also the lead ETF analyst for ETF Central, and he holds The ETF Institute’s Certified ETF Advisor designation.
