For most of the last few years, investors have largely ignored emerging market stocks as the prolonged and positive momentum of the U.S. economy and healthy corporate earnings reports kept them satisfied with stocks closer to home.

Over the five years ended August 31, the annualized return for the MSCI Emerging Markets Index was 5.3%, while the S&P 500 returned 14.4%.

While both markets have moved up this year, emerging markets have taken the lead by a wide margin as investors reward reports of the stronger corporate earnings that began in late 2016 and continued into 2017. As of August 31, Vanguard’s FTSE Emerging Markets ETF (VWO) was up 25% year to date, over twice that of the S&P 500. China staged an especially impressive rebound, with the iShares MSCI China ETF (MCHI) up 42% during the first eight months of the year.

It’s unclear whether the emerging markets upswing is a sign of its short-term frothiness or a longer-term switch in its performance leadership. When you compare them with those in other parts of the world, the stocks aren’t particularly expensive. The MSCI Emerging Markets Index sported a 12.5 forward price/earnings ratio as of August 31, while U.S. stocks’ P/E ratio was 17.8, according to Yardeni.com. The valuations are also more reasonable than those of stocks in Japan and Europe, though the gap is less dramatic than it is with U.S. stocks.

The emerging markets discount relative to the U.S. hasn’t been this wide since 2005, noted a recent report from ETF provider WisdomTree. Beginning that year, the MSCI Emerging Markets Index began a three-year stretch of returning at least 32% annually—significantly higher than the 28.2% cumulative return for the S&P 500 over the same period. Over the last 20 years, the valuation gap between the MSCI EM Index and the S&P 500 has rarely been as large as it is now. Whenever it was, returns for the former index significantly exceeded those for the latter over the next five years.

Emerging market fund managers say that superior economic and corporate earnings growth in these countries could support further momentum. Mark Mobius, the executive chairman of the Templeton Emerging Markets Group, opined in an August report, “While areas of risk remain, our view is that we are still in the early innings of the emerging market earnings growth upturn. We also believe valuations and sentiment continue to be supportive.” Nonetheless, he warned that unpredictable U.S. trade policies, rising political tensions, and the potential for interest rate hikes in the U.S. “could dampen sentiment and lead to market volatility.”

Also in August, mutual fund and ETF giant BlackRock recommended an overweight position in emerging market equities, noting the help they are getting from a synchronized global recovery and dollar weakness. Also, the fund manager is less concerned, at least for the time being, about tighter credit conditions in China, which would lead to a broad deceleration. The fading fears about China has helped improve investor sentiment, says BlackRock. The firm especially favors China, where an uptick in corporate profits is helping wean the country’s companies from dependence on external credit. India, which is undergoing tax and governance reforms that should ultimately prove fruitful, also looks attractive to the firm.

Active, Passive or Smart Beta?

Those considering beefing up or tweaking emerging market allocations can choose from actively managed mutual funds, index ETFs or the newer breed of factor ETFs. Fund managers covering these countries say they are fertile ground for active managers, since investors can take advantage of less efficient markets, buy under-the-radar stocks and make decisive country allocations that differ from widely used benchmarks. The managers note that many market-cap-weighted indexes, by contrast, have a hefty presence in lumbering, poorly managed state-owned enterprises, have more money allocated to China than many actively managed funds and overemphasize slow-growth sectors such as utilities and telecommunications. They also give short shrift to small-cap stocks. If investors are going to use active management for at least some investments, proponents of the practice say this is where it could make a real difference.

But the evidence is mixed that active EM funds beat passive. Certainly Morningstar’s Active/Passive Barometer, which compares active managers against a composite of passive ETFs, presents a generally positive view of active management, at least in this space. Over the five years ending June 30, 2017, only 20.4% of actively managed U.S. large blend funds outperformed their passive peers. But in the emerging market space, roughly 70% of actively managed diversified emerging market funds did so. Over the three-year period, 19% of the U.S. funds outperformed, while 67% of the emerging markets group did.

But the benefit of active management in emerging countries is much more muted in the latest SPIVA Scorecard, an annual publication from S&P Dow Jones Indices. About 12% of U.S. large-cap funds outperformed the S&P 500 over the five-year period ending December 31, 2016, while 25% of emerging market funds outperformed their benchmark indices over the same period. Sixteen percent of actively managed emerging market funds outperformed over three years, versus 7% for large-cap U.S. funds.

Jean Van de Walle, the chief investment officer at Sycamore Capital in Madison, N.J., suggested in a blog that the wide discrepancy between the two studies may be at least partially due to the better performance of the emerging market index used by S&P than the composite results of emerging market ETFs used by Morningstar. He also noted that emerging market active managers may have benefited from the bear market by holding some cash, even though that would harm returns in a bull market. “Furthermore, assuming positive performance for EM equities, indexed products are likely to be more formidable competitors in coming years, as they tend to outperform in bull markets.”

Those going the ETF route can choose from 195 different emerging markets ETFs with over $200 billion in assets. Most investor money has been directed to the three big diversified, market-cap-weighted players that dominate the market.

The largest player in the group is the $63 billion Vanguard FTSE Emerging Markets ETF (VWO). The third-largest ETF in Vanguard’s stable, it follows a market-cap-weighted index of 21 emerging markets and excludes South Korea, a country that makes up about 15% of the MSCI Emerging Markets Index. The VWO fund has an expense ratio of 0.14%.

The iShares Core MSCI Emerging Markets fund (IEMG) has $37 billion in assets and an expense ratio of 0.14%. It does include South Korea, as does the iShares MSCI Emerging Markets fund (EEM), which has $36 billion in assets. The EEM fund, one of the older members of the group, is very similar to the IEMG fund except that it has more large capitalization stocks and a much higher expense ratio (0.69%). The EEM fund also has five times the average daily trading volume of IEMG and a much larger options market, making it the more popular choice for traders.

A smaller diversified offering, the $4.3 billion Schwab Emerging Markets Equity fund (SCHE), offers a worthy alternative to the giants in the space. Its expense ratio is only 0.13%. And like the Vanguard fund, it has no exposure to South Korea.

All these market-cap-weighted ETFs have a hefty allocation to China ranging from 26% to almost 30%.

Factor ETFs are also a growing slice of this segment. Because of their index construction, many have country weightings, stock holdings and performance that differ significantly from those attributes in the more popular traditional market-cap-weighted benchmarks.

For instance, the $4 billion iShares Edge MSCI Minimum Volatility Emerging Markets fund (EEMV) consists of stocks from the MSCI Emerging Markets Index that have enjoyed a history of low volatility. The fund, which has an expense ratio of 0.25%, has less in basic materials and energy than the MSCI index, and more in health care.

The $1.6 billion Schwab Fundamental Emerging Markets Large Company multi-factor fund (FNDE) selects stocks for its index based on the companies’ sales, cash flow and dividends. It has a lower allocation to China than the major market-cap-weighted funds and more to South Korea. Its expense ratio is 0.40%.

Launched in 2015, the $1.5 billion Goldman Sachs ActiveBeta Emerging Markets Equity fund (GEM) is one of the newer members of the group. The fund has an expense ratio of 0.50%. Its universe is the MSCI Emerging Markets Index and it focuses on four styles in the companies it seeks out—value, momentum, quality and low volatility. The firm says these qualities are associated with companies’ superior long-term performance.

WisdomTree also has a suite of factor ETFs, including the $1.3 billion Emerging Markets SmallCap Dividend Fund (DGS), which has an expense ratio of 0.63%, and the $2 billion Emerging Markets High Dividend Fund (DEM) whose expense ratio is 0.63%. Like other ETFs in the family, these follow a fundamentally weighted index of high-dividend-yielding stocks. The small-cap fund recently had a distribution yield of 4.5%, while the DEM fund’s yield was 3.9%.

Single country funds can serve as a complement to more diversified emerging markets holdings. This group includes the iShares MSCI India fund (INDA), the iShares MSCI China fund, the VanEck Vectors Russia fund (RSX) and the WisdomTree India Earnings fund (EPI). Because these tend to be even more volatile than diversified funds in this category, buying on dips is a good strategy here.

Even with more diversified emerging country funds, the markets can move so swiftly and dramatically that keeping an eye on valuations and avoiding froth is critical. The major emerging market ETFs around in 2008 lost more than half their value in less than six months. That kind of nosedive is not something anyone other than short sellers would like to repeat.