Still emerging
NEW YORK – Investors who poured money into emerging markets mutual funds the last two years may be feeling a little uneasy after the funds’ sharp decline over the past month. Fund analysts aren’t so worried – they say the downturn is only a correction in markets that are fundamentally strong.
And, they say, while these investments are risky, emerging markets deserve a place in a long-term diversified portfolio.
After delivering a three-year return of more than 40 percent, emerging markets funds had a negative return of 8.41 percent in the past month, pulling its year-to-date return down to a still-hefty 10.23 percent, according to fund tracker Morningstar Inc.
“The recent sell-off is not a sign of long-term trouble,” said Arijit Dutta, a mutual fund analyst at the research firm Morningstar. “People were chasing performance, so with so much cash going in, it is bound to cause the markets to overheat.”
Emerging market funds had cash inflows in the United States of $23 billion in the first quarter of 2006, equaling the total for all of 2005 and more than five times the level in 2004, according to Brad Durham, managing director at Emerging Portfolio Fund Research.
“They got ahead of themselves because of excessive liquidity,” Durham said. “The market was due for a correction.”
That came as a huge outflow – some $5 billion – in the week ended May 24, Durham said.
Analysts say emerging markets funds are essential for long-term investors seeking growth. Julian Thompson, portfolio manager for RiverSource Emerging Markets Fund, recommends holding funds at between 5 percent and 20 percent of a portfolio.
Morningstar’s Dutta is less bullish. “We have been saying for more than a year to cut holdings in emerging markets to about 5 percent to 8 percent,” he said. “If your portfolio has gotten out of balance because of the huge gains, then now would be a good time to take some chips off the table and put them somewhere else.”
Dutta advises caution because the funds are by nature risky, targeting companies based in so-called developing economies where volatility is high and the risk of an economic collapse is real. “Emerging markets do have a role to play, but it should be limited because of the volatility,” Dutta said.
There has been talk that the recent downturn – led by a sell-off in India that sent the country’s stock market tumbling – is the start of a new period of volatility. The reversal started over concerns that China might slow its economic growth to prevent its economy from overheating, said RiverSource’s Thompson.
“That was overblown,” he said. “China’s performance has been profound and it will continue to support commodity prices.”
Thompson, meanwhile, said the three-year run was not an aberration, but became possible because of more stable markets.