Jitters afflict emerging market investors

Tribune staff reporter

Perhaps nowhere has investing become more confusing than in foreign markets.

With the aid of the falling dollar and an ongoing overseas economic growth spurt, international investing has been kind to investors. International stock mutual funds have climbed about 100 percent over the last five years--or almost twice as much as the average U.S. stock mutual fund. And emerging market funds, which invest in developing areas such as Russia, India, Brazil and China--are up almost 200 percent, according to Lipper Inc.

Yet investors have become jittery recently as China tries to turn down the roar of its growth a little--without going too far.

In addition, investors are growing increasingly nervous that the United States will go into a recession and drag down the world as U.S. consumers buy less from abroad.

Until recently, investors were treating emerging market funds as though they were immune from the U.S. housing problems and credit crunch.

In fact, they poured money into emerging market funds, while fleeing from stocks in the U.S., Europe and Japan, noted Brad Durham, managing director of EPFR Global, a firm that tracks the flow of money into various types of investments. It was a strange twist, because typically emerging markets have crashed hard at the first sign of distress in the U.S. economy, he said.

This time, with investors worried about a worsening U.S. housing recession and the worldwide drag of a growing credit squeeze, investors favored two investments that seem at opposite ends of the spectrum--emerging market funds, which are usually considered the most dangerous of funds, and money market funds, which are considered the safest.

Between the end of August and Nov. 14, investors poured $30.5 billion into emerging market funds and $89 billion into money market funds, Durham said. The thinking was that the powerful growth exhibited in emerging markets would continue as the nations sold commodities such as oil and copper to the world and benefited internally from consumption by a growing middle class.

But the mood has changed quickly.

"Although China, the rest of Asia, and other emerging markets have been insulated so far from the credit squeeze and higher oil prices, the risks of a boom-bust scenario are uncomfortably high," said Global Insight economist Nariman Behravesh, in a note that encapsulated a growing view among economists and Wall Street strategists. "China faces a growing risk (a 30 to 35 percent probability) of suffering a hard landing for purely domestic reasons. Such a scenario in China would likely push down commodity prices and hurt commodity-exporting emerging markets."

As fear built this month, investors pulled money out of emerging markets.

Although still modest, the flow of money out of the emerging economies was more than twice the flows out of Europe. Investors pulled $5.6 billion out of emerging market funds the week of Nov. 11, while taking $2.3 billion out of European funds and $1.6 billion out of global funds, which invest anywhere in the world.

Flows out of the U.S. stock funds had been strong, but slowed to $319 million.

This is not a time for investors to ignore their international investments and hope for the best, said Richard Ferri, a Troy, Mich., investment adviser with Portfolio Solutions LLC. Investors who bought emerging market funds in the past are probably holding supersize portions now because the stocks have soared so powerfully.

He suggests reviewing portfolios and cutting emerging market funds back to original intended proportions--perhaps 5 percent of a portfolio. And when he suggests a review, he means going beyond looking merely at fund names and descriptions. Because emerging market stocks have been hot, even U.S. stock funds and diversified international funds may have emerging market stocks. For example, fund tracker Morningstar Inc. noted in October that funds such as Marsico Focus, which typically invests in U.S. stocks, had 4.7 percent of the fund invested in China.

China and emerging markets add return when they are strong, but large bets will hurt portfolios if investors sour on them. That's why Ferri suggests checking for overexposure now, while there is time to make adjustments without taking a loss.

Morningstar has an "X-Ray" tool on its Web site that allows you to insert all of your funds and see how they are investing your money. To spot emerging market stocks, look for areas such as Latin America, Africa, and Asia other than Japan.

You can find the tool by clicking on the "portfolio" tab on the home page and using the drop-down menu under "portfolio manager," going to "Instant X-Ray."

Investors who have been holding individual emerging market funds and are no longer sure how to evaluate them, or how much to hold, also could make life easy on themselves by buying an international mutual fund run by a manager with the leeway to invest anywhere in the world. But this is a little tricky. Some of the funds that look the most enticing may be the most vulnerable if emerging markets fall, because many have made large bets on emerging markets.

For example, Masters Select International, Oppenheimer International Growth and Thornburg International Value have recently been singled out by Morningstar analyst William Samuel Rocco because they have strong longer-term records and outstanding returns this year. But Rocco has warned investors that the outstanding returns have come largely from bets on emerging markets that won't continue indefinitely.

"Investors should be sure they understand that the big absolute gains that many foreign funds have posted in recent years aren't sustainable," Rocco said in a report on Thornburg. "They should recognize that the fund's interest in emerging-market stocks and issue concentration could lead to rough spells in the future."

On the other hand, well-respected funds such as Oakmark International and Oakmark Global have avoided emerging markets. Portfolio manager David Herro has expressed concerns that stocks are pricey.

Investors who don't want to take a chance that funds will make an oversized bet on emerging markets could simply buy an index fund that invests in the entire world, except the U.S.

Ron DeLegge, of ETFguide.com, suggests selecting one of two exchange traded funds--the Vanguard FTSE All World ex-U.S. ETF, which trades under the symbol VEU, and the SSgA's SPDR MSCI All-Country World Index ex-U.S., which trades under the symbol CWI. Both invest in developed areas such as Europe and Japan, plus emerging markets.

Gail MarksJarvis is a Your Money columnist. Contact her at gmarksjarvis@tribune.com.

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