Four funds to smooth emerging markets' bumps

By Mark Jewell

AP Personal Finance Writer

BOSTON (AP) -- Mutual fund investors are clearly scared of U.S. stocks. Yet they're rushing into another area with even more risk: emerging markets.

While the Standard & Poor's 500 surged to its best September showing in more than seven decades, investors pulled $16 billion more from U.S. stock mutual funds than they put in, according to Morningstar.

Many looked to faster-growing countries like China, India and Brazil. Investors put $3.5 billion more into emerging markets stock funds during September than they took out, bringing the total for this year to $18 billion.

U.S. stock funds' total? Investors have withdrawn $58 billion more than they've put in.

Investors adding emerging markets holdings to mostly U.S.-focused portfolios will typically boost their returns. This year, for example, emerging markets funds have returned an average 14 percent, more than double the nearly 6 percent gain for the S&P 500.

But it comes at a price of greater volatility. Stocks from countries with economies that are still maturing typically rise faster and fall harder than U.S. stocks, a story that played out in the 2008 meltdown and 2009 recovery. The pattern repeated itself last quarter, when emerging markets funds surged 18 percent, compared with 11 percent for U.S. stock funds.

So how do you profit from emerging markets without taking on more risk than you can stomach?

A few tips:

--Don't go overboard: Figuring out an appropriate percentage of emerging markets holdings in a diversified stock-and-bond portfolio isn't easy. Generally, don't keep more than 5 percent to 10 percent in funds that focus on stocks of companies in emerging markets, or from specific countries like China or regions like Latin America.

You might already have more emerging markets exposure than you think. That's because funds specializing in stocks of large foreign-based companies typically keep about 10 percent in emerging markets, alongside stocks from European countries and other developed markets, says Bill Rocco, a Morningstar fund analyst. And many of the biggest U.S. companies already rely heavily on sales in developing countries -- Coca-Cola and Procter & Gamble, for example.

"It's easy to overdo it," Rocco says. "You're already getting a lot of indirect emerging markets exposure through large-cap funds, whether they're U.S. or foreign funds."

-- Be patient: To deal with the greater volatility, think long-term, and avoid the temptation to make sudden shifts in or out of emerging markets.

-- Prepare to pay: The average diversified emerging markets fund charges an expense ratio of 1.74 percent, compared with 1.37 percent for U.S. stock funds, according to Morningstar, Emerging markets funds charge more primarily because it costs more to research and trade overseas stocks than U.S. stocks. An expense ratio measures the ongoing charges that investors pay, expressed as a percentage of assets.

If you're concerned about excessive volatility, below are four emerging markets funds screened by Morningstar that may work for you. All posted returns in the top half of their peer group over the past 1- and 3-year periods, and in the top 25 percent over five years. Each had below-average volatility compared with other emerging markets funds, based on a measure known as standard deviation. Their expense ratios are below average compared with peers. They all require less than $5,000 as a minimum initial investment, so they're within reach of most investors of modest means. And none is currently closed to new investors.

One caution: Three of the funds have upfront sales charges known as loads. Investors thinking about such a fund for the short haul should consider whether the upfront cost is too steep.

The list, ranked by order of the funds' 5-year returns:

-- Invesco Developing Markets (Ticker: GTDDX): Ranks within the top 5 percent of its peers with an average annual return of nearly 18 percent over the past five years. It's broadly diversified, holding a mix of large, medium and small stocks. It tends to hold individual stocks for a long time, with low portfolio turnover. About four-fifths of its holdings are in emerging markets, with the rest in developed markets. One drawback is its 5.5 percent sales load. At 1.66 percent, its expense ratio is slightly below average for its category.

-- Oppenheimer Developing Markets (ODMAX): The largest fund in the group, with nearly $18 billion in assets, and the lowest expense ratio at 1.43 percent. But it charges a 5.75 percent load. About three-quarters of the holdings are in emerging markets, with more stocks in companies from India than most of its peers.

-- ING JPMorgan Emerging Markets Equity (IJPIX): This fund is relatively cheap, with an expense ratio of 1.51 percent. Unlike the others, it has no sales load. The fund's four-person management team typically holds five to six dozen stocks, with an emphasis on large companies, about three-quarters in emerging markets. Recently, the fund cut its holdings in telecommunications companies, and added more consumer and financial stocks.

-- Virtus Emerging Markets Opportunities (HEMZX): The top performer in the group over the past 12 months, finishing in the top 3 percent of its peer group with a nearly 27 percent gain. The fund emphasizes large emerging markets companies, and recently had a relatively small 13 percent of its portfolio in developed markets stocks. Its 5.75 percent load is a drawback. Its expenses of 1.72 percent are slightly below the category average.

Published: Tue, Nov 23, 2010