Turkey, Thailand, Russia, Vietnam, South Korea, Indonesia, Qatar, GEM debt...no doubt you're currently much more familiar with the investing opportunities in these regions than you were a year or so ago. Investors really can't be blamed for taking a second look at the year's hottest fund categories. In 2009, the Latin America equity fund category achieved returns well over 100%--who could be blamed for sitting up and taking note? And in 2010, it's consistently been the emerging economies that are underpinning global economic growth; without their driving force the global economy would be looking a lot more stagnant at present. And forecasts for the future growth of this region continue to look rosy. But it's paramount that investors remember, at the very least, these two cavaets: economic growth doesn't necessarily lead to stock market growth; chasing hot returns can quickly result in a cold shower.
Will Emerging Markets Continue to Rally?
We're hearing arguments on both sides of the fence. Matthews Asia Funds portfolio manager Andrew Foster told my colleague Jason Stipp that it's time for investors to cool down or even reset their expectations for the performance of the emerging markets region in the coming years.
On the flipside, Schroder's Head of Emerging Market Equity, Allan Conway, told me just days ago that this popular destination for investors' assets is far from overheating and the bubble's got more capacity before it's likely to burst--an event that he doesn't see happening before 2012.
Meanwhile, T. Rowe Price fund manager Gonzalo Pangaro said in a recent interview that he wouldn't be surprised to see a correction in emerging markets in the short term but he remains constructive in the medium term and valuations are still reasonable in the region.
Whichever view you subscribe to, there is certainly a case to be made for investing in emerging-markets securities for the long term. They offer diversification as well as very strong long-term capital appreciation potential. Many of those who specialise in the area believe that the fundamentals are strong and that developing-market countries offer compelling valuations and excellent prospects.
For investors who decide they want to add some emerging-markets exposure to their portfolio, choose carefully. Don't just pick the best performers and pay particular attention to how funds have held up during the sell-offs, such as 2008 and early 2009.
Keep diversification in mind as well. Investors have tended to get very excited over the sometimes spectacular returns produced by narrower mandates, but during a sell-off, regional and single-country funds can take the biggest hits because of their market risk and sector concentration. Geographic breadth and a diverse mix of stocks will serve you well over the long run in terms of reducing volatility--at least as much as one can in this area. (For a synopsis of some of our preferred emerging markets funds, read Six Top Funds for Volatile Markets.)
Is it Too Late to Join the Party?
Buying into any asset class after a period of strong returns can be dicey. You could be buying in at exactly the wrong time--plunking down a pile of your hard-earned cash into a fund only to see performance fall off a cliff. Certainly 2009 was a real eye-catcher in terms of spectacular returns, and while 2010 performances have continued to far exceed those of their more developed cousins they haven't been quite as eye watering. Could we be set to start the next installment of the multiyear rally, or should we be preparing for the region to take a swan dive?
The truth is, it's impossible to know. If you could accurately predict which scenario would come to pass, you would know exactly how to invest. But because market-timing this asset class is notoriously difficult, pound-cost averaging, or investing fixed amounts into an investment at regular intervals over time, is a wise move. By pound-cost averaging, you won't miss out on good growth if the rally continues because you will have some exposure, but you won't get crushed if emerging markets sell off quickly, because you didn't put all your money on the table. Perhaps the most important advice is to have realistic expectations. Don't assume you will double your money over the next nine months.
Before You Invest--Take Stock!
Before you embark on your pound-cost averaging adventure, take stock of your portfolio and see how much exposure to emerging-markets assets you already have. You may have plenty even if you don't own an emerging-markets fund. Many broad international funds have substantial emerging-markets stakes within their portfolios, for example.
It doesn't end there. Look at your current allocations, especially in light of recent performance, and you might be surprised. You need to look at the whole picture--you may well discover you're already exposed to emerging markets via an international large-cap fund.
A useful tool on Morningstar.co.uk is Instant X-Ray, which allows you to quickly and easily size up your portfolio's diversification. To use it, enter the ticker symbols and pound amounts or percentages for each of your holdings (which can include both funds and individual stocks), and then click Show Instant X-Ray. You can also save your portfolio to Morningstar.co.uk's Portfolio Manager for future reference, which makes monitoring your allocations and preparing for rebalancing easy.
