BUSINESS

Regaining strength: Emerging-market funds cruising again

Staff Writer
Columbus CEO

NEW YORK (AP) — Emerging-market stock funds are making big moves again, and this time it's in the good way.

Stocks from China, Brazil and other developing economies have a history of big swings, up and down. The group has had uncharacteristically muted returns the last couple of years, but that's changed this year. The MSCI Emerging Markets index, which many funds use as their benchmark, has already posted a return of nearly 9 percent in U.S. dollar terms.

A resurgent Chinese market is helping to lead the way, and even formerly downtrodden markets like Russia have bounced higher. The index is on a pace similar to its performance from 2003-12, when it rose or fell by at least 15 percent each year and typically by multiples of that.

Investors plugged $4.2 billion into emerging-market mutual funds and exchange-traded funds in March, making it the fifth-most popular category of the 110 that Morningstar tracks. Even with their recent gains, many managers say emerging-market stocks are cheaper than their U.S. counterparts relative to how much profit those companies are earning.

But before you join the crowd, it's important to remember those historically big swings. Plus a potential boogeyman is looming, one that's knocked down emerging markets in the past: the Federal Reserve.

Investors worldwide are bracing for the Fed to raise interest rates later this year. Higher rates in the U.S. could draw investment dollars away from emerging markets. It could also dent the value of the Turkish lira, Indonesian rupiah and other currencies, undercutting the returns of those local markets when counted in U.S. dollars.

Some foreign stock funds blunt the effect by using futures to "hedge" against moves by the euro or Japanese yen. But hedging emerging-market currencies is much more expensive, so such funds generally don't do it.

A sneak preview may have been offered in the spring of 2013, during what's called the "taper tantrum." U.S. rates jumped on worries that the Fed would scale back its bond-buying stimulus program, and the average emerging-markets stock mutual fund lost 6.6 percent in June alone.

To be sure, thinking about emerging-market stocks in generalities can be a mistake. The label encompasses nearly two dozen countries, where economies and central banks are moving at different paces. Some are reliant on energy prices being high, such as Russia, while others do better when oil is cheap, such as India.

"When you think about emerging markets, they tend to get lumped together, but it's unfair to think that they all move in the same direction," says Patricia Ribeiro, portfolio manager at American Century's Emerging Markets fund. She looks for stocks where revenue and earnings growth is accelerating, and she says she's finding them even in economies where growth is slowing.

Here's a look at how several markets are performing:

— BRAZIL

Brazilian stocks have been good this year, for anyone sitting in Rio de Janeiro. They have returned 13 percent in reals. But the real has been tumbling in value, so they are close to flat in dollar terms. Economists say Brazil's economy is on pace to contract this year, a drought is sapping its water reserves and a kickback investigation at oil giant Petrobras has hurt confidence.

— CHINA

The MSCI China index began rising late last year and spiked in April to its best month since 2007. Several factors are behind the rise, including expectations that China will keep cutting interest rates to help its sharply slowing growth rate.

Chinese stock prices have run up so quickly that Paul Attwood, portfolio manager at the Huntington Global Select Markets fund, wants to see either a price drop or better economic reports before buying more. Although he still generally likes Chinese stocks as long-term investments, he sees signs of a potential frenzy. One particularly concerning signal for him was when he read that Chinese investors opened 4 million brokerage accounts in March alone.

— INDIA

Indian stocks were some of the world's best last year stemming from optimism about the country's new prime minister. Investors expected Prime Minister Narendra Modi to push through reforms to unshackle the economy. The market has since slowed, and Indian stocks are close to flat for the year. Managers say it's likely a result of reforms not moving as quickly as hoped, as well as investors selling Indian stocks to lock in profits.

— RUSSIA

The plunging price of oil, tumbling value of the ruble and worries about tensions surrounding Ukraine meant Russian stocks lost 46 percent last year in dollar terms. But the price of oil has since stabilized, reaching $60 per barrel this month after sinking to nearly $42 in mid-March. That plus bargain-hunting by some brave investors has pushed Russian stocks to generate a return of 45 percent this year, though many managers say they're still wary.