Emerging Markets Soar but Remain Risky
By Andrew Leckey
The Ups & Downs of the Stock Market
Emerging markets are like those giant slices of double-mud chocolate-brownie cake offered to you by restaurant servers at the end of your meal.
You run the risk of a severe stomachache later, but they sound so good it's hard to resist.
In 2009, emerging markets mutual funds are up an enticing 54 percent, according to Lipper Inc. That indicates developing nations have the capacity to survive global economic trauma and investors are regaining an appetite for risk.
Here's the stomachache: For the 12-month period that included the initial global economic panic, they're still down 28 percent.
"Emerging markets have rebounded better than anywhere else and are a really hot area, with investment flows into emerging market mutual funds really strong," said Alec Young, international equity strategist with Standard & Poor's Corp. in New York. "Just don't forget this is a volatile area in which individual investors are often late to the party."
In some cases, emerging market countries have acted more grown-up and less panicked than their established rivals.
"We've seen that emerging countries have become much better in managing their own finances and the macroeconomic environment," said Patricia Ribeiro, portfolio manager since 2006 of the $469 million American Century Emerging Markets Investors Fund (TWMIX) in New York, up 28 percent this year.
"We didn't see any major meltdowns in which any emerging market countries had to devalue their currencies because they couldn't defend them."
In the 1980s and 1990s, emerging markets would implode on most any type of world stress, Ribeiro said.
It is also a positive sign that more of these nations' citizens are investing in their own markets.
Although the economic environment remains difficult, she is convinced the most significant growth in the next two years will be in developing countries.
"Today, to have a diversified portfolio, you must look at emerging markets," Ribeiro said.
China, India, Brazil and Russia are the biggest country allocations in her fund.
China's stimulus package has proven effective; India has lowered interest rates and targeted infrastructure improvements; and Brazil, driven more by domestic than global factors, has created mechanisms to make lending easier, she noted. Russia is riskier because it is so dependent on oil prices and has a lot of debt.
Ribeiro's top stock holdings include South Korea's Samsung Electronics and Hyundai Motor Co.; Brazilian oil and gas company Petrobras and industrial materials company Vale; hardware maker Taiwan Semiconductor Manufacturing; and Israel's Teva Pharmaceutical Industries Inc.
"Emerging markets are going to come out of the recession before we do," predicted Gary Gordon, president of Pacific Park Financial in Aliso Viejo, Calif.
"For example, a 'bad' year for China is 7 to 8 percent growth, and its stimulus package is $600 billion with 75 percent going toward infrastructure."
The U.S., Japan and the developed nations of Europe are likely to be the last to emerge from recession, Gordon said. And while major world markets hit multiyear lows in March, emerging markets hit their lows in November.
The best way to invest in emerging markets, Young believes, is a broad-based index available through either an exchange-traded fund or a mutual fund, with plenty of choices available in each.
For example, the Vanguard Emerging Markets ETF (VWO) tracks performance of nearly 800 stocks of companies in emerging markets. Vanguard Emerging Markets Stock Index Fund (VEIEX) is a comparable mutual fund.
"We endorse the idea of choosing an index over an actively traded emerging markets fund to invest in emerging markets," Young said. "That's because the more exotic an asset class, the higher the expense ratios can go for actively managed funds, making it difficult to beat its benchmark index."
Only a small portion of an individual's portfolio should be dedicated to emerging markets, he said.
For example, S&P's "moderate risk" model portfolio of 60 percent stocks and 40 percent fixed income includes 5 percent of the stock portion in emerging markets.
Emerging markets ETFs that look good to Gordon include:
iShares FTSE/Xinhua China 25 Index (FXI) that consists of 25 of the largest and most liquid Chinese companies.
Claymore/AlphaShares China Small Cap (HAO), which tracks the AlphaShares China Small Cap Index that monitors publicly traded mainland China small-capitalization companies.
Market Vector Brazil Small Cap (BRF), which focuses on some of the smaller companies in that country and takes advantage of the strong consumer base there.
iShares MSCI Emerging Markets Index (EEM) that covers a broad mix of emerging markets around the globe.
For obvious reasons, a single-country ETF carries greater potential risk than one that spreads risk around among many different countries.
Check your holdings to see whether you might already have adequate emerging markets coverage.
Morningstar Inc. calculated that most foreign large-cap funds have 8 percent to 13 percent of their assets invested in the developing world. Emerging markets holdings are frequently found in diversified stock funds.
"Since you have to protect against downside risk, don't buy an emerging markets investment and hold for a decade," Gordon said.
"If you see it has made 80 percent over the past two years, maybe take a little profit off it, since holding forever is definitely not the way to go with this group."
Basic materials stocks sound about as exciting as freshly laid asphalt, but they've become a steaming-hot investment in 2009. This group was devastated last fall as hedge funds abandoned the then-dominant thesis that the world -- especially Asia -- needs to keep building, and summarily dumped the stocks. However, ambitious economic stimulus packages in the U.S. and abroad have revived the need for basic materials.
Despite the market's roaring rally over the past three months, some stocks--including those of well-known companies--still look cheap. So how do you separate the deals from the duds? Understand why the stock is cheap.
(Andrew Leckey answers questions only through the column. Address inquiries to Andrew Leckey, 555 N. Central Ave., Suite 302, Phoenix, AZ 85004-1248, or by e-mail at email@example.com.)
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