Emerging markets stocks have been staging an impressive rally on global exchanges, delivering a robust return of 39% over the twelve-month period ending in August. For investors seeking growth beyond developed economies, this broad market surge has provided a lucrative window. However, this rising tide has not lifted all boats equally, leaving prominent portfolios like the Baron Emerging Markets fund (BEXFX)—a respected member of the Kiplinger 25 list of top no-load mutual funds—out of the absolute top tier of performers for the moment.

Despite delivering a solid 24% gain over the same twelve-month stretch, the fund finds itself lagging behind the broader benchmark, the MSCI Emerging Markets Index. This performance gap represents a notable shift in fortune for the fund, which only a few months prior was tracking much more closely with its benchmark index. While a 24% absolute return on a standalone basis is far from disappointing for most portfolio managers, the relative shortfall has drawn the attention of market analysts tracking top-tier mutual funds.

Tech hits a rough patch

A primary catalyst for this recent lag can be traced directly to the performance of technology stocks, which have hit a noticeable rough patch after a period of stellar growth. Several of the fund’s heavy-weight holdings within the technology sector were explosive outperformers throughout 2005 and early 2006, serving as the core engines driving the fund’s impressive historical returns. Unfortunately, those very same market leaders have experienced a sharp pullback in recent months, dragging down aggregate portfolio returns.

The correction has hit semiconductor and hardware giants particularly hard. Shares in Taiwan Semiconductor Manufacturing Company (TSM), which accounted for a substantial 16% of the fund’s assets at the last portfolio report, have slipped 13% over the past two months alone. Major South Korean technology anchors have experienced even steeper corrections over the same timeframe. Samsung Electronics, representing roughly 8% of the portfolio, has watched its shares slide by 28%, while fellow memory-chip giant SK hynix, accounting for 7% of portfolio assets, has pulled back by 12%.

Compounding these sector-wide headwinds, shares in major Chinese technology firms, including e-commerce titan Alibaba Group Holding (BABA) and internet conglomerate Tencent Holdings, have also acted as an anchor on the fund’s performance since the beginning of 2006. Regulatory shifts, broader macroeconomic pressures in mainland China, and shifting investor sentiment toward Chinese equities have weighed heavily on these mega-cap names, making it difficult for active managers heavily invested in the region to match index-level returns over the short term.

Addressing these performance dynamics in a report covering the quarter that ended in June, portfolio manager Michael Kass expressed that he remained quite encouraged by the strong absolute performance of the fund despite the relative underperformance. Looking at a slightly broader lens, the fund has generated a cumulative gain of 50% since the start of 2005. While undeniably impressive for a multi-year stretch, that figure still trails the 66% cumulative return posted by the MSCI Emerging Markets Index over the exact same period.

When evaluated over longer investment horizons, however, Baron Emerging Markets reveals a much more competitive track record that validates its standing among professional selectors. The fund boasts a 15-year annualized return of 6.3%, a figure that places it comfortably within the top 31% of all diversified emerging-markets stock funds. Furthermore, this long-term annualized performance manages to edge out the MSCI Emerging Markets Index, which sits at a 6.0% annualized return over the same long-haul period, demonstrating the value of active management through complete market cycles.