Keep Emerging-Market Investing in Perspective

The sideshow’s over, and it’s time to head back to the main tent. That’s the way Michael Perelstein, lead portfolio manager for two new MainStay International funds, sizes up the global-investment arena.

At a time when investors’ passion for emerging stock markets has never been higher, Perelstein is recommending that fund shareholders get back to basics--which in his view means the established foreign markets of Western Europe and Japan.

In fact, he has recently reduced the emerging-markets exposure in the MainStay funds and the other foreign portfolios he runs to zero, while boosting Japan to 35% and Western Europe to 65%. Perelstein oversees $500 million for MacKay-Shields, a New York firm that manages the MainStay funds.

Perelstein’s belief that the world’s developing nations aren’t worth investing in at current prices is debatable. But his caution is well-advised considering the recent flood of money that has headed into international mutual funds generally and Third World portfolios in particular.

Shareholders would be wise to keep emerging-markets investments in proper perspective, best viewed as dessert rather than the main course.

And with the economies of Japan and Western Europe finally emerging from recession, that idea is becoming more palatable.

“The emerging-markets rationale made sense when the developed economies weren’t growing,” says Perelstein, who hails from a country with an emerging market, Israel.

“But now the cycle’s turning in Europe and Japan.”

It’s not an isolated message.

Heinrich Looser, a top investment official at Switzerland’s Bank Julius Baer, says he currently finds only two emerging Asian markets attractive, Thailand and Taiwan, but likes several European markets, including Germany, France and Switzerland.

“The growth rates in the European economies have been picking up nicely over the last six months,” says Looser, who is predicting a 10% to 15% rise in those key markets by mid-1995.

Perelstein said he thinks German corporate profits could advance 30% this year, with profit increases of up to 25% in Japan over the next 12 months.

An emerging-markets enthusiast who avoided Japan would have missed nearly a 20% average gain through the first nine months of this year.

More critical, some people might not appreciate the greater economic and political risks of investing in small markets where declines of 30% or 40% aren’t uncommon.

Mutual funds are excellent vehicles for diversifying these risks, but the voracious buying and selling power of emerging-markets funds has itself added an element of volatility.

“This huge flow of cash into international markets seems to have upset the normal supply and demand, particularly in the very small marketplaces,” says Harry Papp of L. Roy Papp & Associates, a Phoenix fund-management company that sticks exclusively with American stocks and those of a few developed nations.

Perelstein agrees. “There are no institutional buyers in many of these emerging markets, only U.S. mutual funds,” he says.

Conversely, there’s no question that developing nations such as China, Mexico and India will offer exceptional growth opportunities over the long haul. But fund shareholders should keep in mind that all such markets currently weigh in at only one-tenth or so of the global value of all stocks, so it’s best not to go overboard.

Several well-known international funds--including EuroPacific Growth, T. Rowe Price International, Templeton Foreign and Warburg Pincus International--have been maintaining ample stakes in Third World nations anyway, sometimes in excess of 33% of assets. Adding a pure emerging fund on top of this could bump up your overall risk substantially.

Jay Penney, an investment adviser at the Acacia Group in Phoenix, suggests that middle-of-the-road investors earmark 15% to 20% of their overall fund holdings to foreign markets, but only one-third of that in the emerging sphere.

For aggressive shareholders, he suggests roughly a 30% foreign weight, with one-third of that in emerging nations.

These postures would imply a 5% to 10% overall position in developing countries.

“A 10% stake can have a dramatic effect on your portfolio, if it grows 35% a year annually over time, which I think is possible,” Penney says.

“But you have to realize that these funds will be among the most volatile investments in your portfolio.”

Moral of the story: Invest in emerging markets via mutual funds, but don’t put them at the core of your foreign holdings.

Scudder, Stevens & Clark has opened a walk-in investor center in San Diego, at 9450 Scranton Ave. The no-load fund group has nine other offices across the country, including centers in Los Angeles and San Francisco.

Third-World Slice

Investors might want to be wary of getting carried away with mutual funds that invest in emerging economies of Asia and Latin America, given that the stock markets in these nations remain relatively small.

Here is how selected nations and regions weigh in as a percentage of global stock market values.

United States: 34.6%

Japan and Hong Kong: 25.3%

Europe: 24.3%

Emerging Asia: 7.5%

Australia, Canada, N.Z.: 4.0%

Latin America: 3.2%

Other: 1.1%

Source: “The GT Guide to World Equity Markets 1994-1995.”