Now's a Good Time to Tiptoe Into Emerging Markets
Emerging markets have had a long and stunningly profitable run. The average diversified emerging-markets fund has returned an annualized 35% the past three years. That's huge.
With such a big move behind them, emerging markets may be due for a correction -- or even a full-fledged bear market. But the long-term case for emerging markets is so compelling that I still think you should climb aboard.
Not with both feet, though. Instead, tiptoe in. This is an ideal time to slowly dollar-cost average into a good emerging-markets fund. Investing a little bit in a fund each month may be boring, but it really does smooth out the peaks and valleys in your returns -- and allows you to invest in a risky variety of stocks without losing sleep.
Why emerging markets? Anyone who has talked to a help desk in India or has bought Chinese products (and that's just about everyone) understands that technology is changing the global rules. The have-not countries -- so long as they have an educated populace willing to work hard -- are experiencing rapid, if uneven, growth.
The best is almost certainly still to come for many of these countries. The workforce is aging in Europe, in Japan and, to a lesser degree, in the U.S. As baby boomers in the developed nations begin to retire, a much younger population in developing nations could supply much of the labor needed to build a better world.
What's more, even with the dramatic move in stock prices in emerging markets, valuations are still quite reasonable. That's partly because their economic growth has been so rapid, too. On average, emerging-markets stocks trade at price-earnings ratios of a little more than 10 based on 2006 estimates. U.S. stocks, by contrast, trade at a P/E of around 17.
What could go wrong? Anything. A devaluation of Asian currencies touched off a vicious bear market in emerging markets just seven years ago. India and Pakistan could really go to war -- and both sides have nukes. India carries the burden of its lethargic government bureaucracy and a woefully inadequate infrastructure. Corruption at all levels is a constant threat to China's economic miracle. Latin America is undergoing one of its periodic lurches to the left, and parts of Africa are stymied by civil war and AIDS. Moreover, corporate accounting in emerging markets isn't nearly as transparent as it is in the U.S. Companies are often run for the managers, or the state, rather than U.S. shareholders.
Those are sound reasons to limit your emerging-markets exposure to 5% or so of your stocks. Before you invest in a dedicated emerging-markets fund, be sure to check your foreign funds to see how much they have invested in emerging markets.
Test the Waters
Good funds? I'll name two. Frankly, it's almost impossible to choose between them.
T. Rowe Price Emerging Markets (PRMSX) is my favorite, but only by a hair. It has returned an annualized 40% over the past three years and an annualized 19% over the past five years. Expenses are low at 1.27% of assets annually. T. Rowe is a fine company, and it's trying to upgrade its foreign funds, which haven't been its strong suit in recent years. A quartet of managers stationed around the globe pick stocks for this fund. Two have been on the job more than a decade. Like most emerging-markets funds, this one's biggest bet is on Asia (excluding Japan), where it invests 42% of assets. Twenty percent of assets are in Korea, 14% in Brazil.
SSgA Emerging Markets (SSEMX) is a very close second. The returns have been essentially identical to those of the T. Rowe fund. Expenses are just 1.25% annually. Manager Brad Aham has steered the fund since the mid 1990s. He's supported by a team of eight analysts. Half of assets are in Asia. The fund has 22% in Korea and 13% in Brazil. Truly, this fund looks a lot like the T. Rowe fund: Both seek to -- and have -- beaten the emerging-markets indices by a little, rather than trying to hit home runs.
Opinions expressed in this column are those of the author.