Is Now the Time to Jump into Emerging Markets?

these days. After a powerful three-year rally stretching into the spring of 2006, during which indexes in some countries rose several hundred percent, emerging markets endured a steep downturn from mid-May to mid-June, sparked by concerns about inflation, rising interest rates, and geopolitical crises. From May 10 to June 13, in fact, Morningstar's Emerging Markets Equity category plunged more than 20% on average. Since then those markets have bounced back some, but they remain significantly lower than they were this spring. And given their volatility, by the time you read this they might be lower still.

With that in mind, we've been asking international-fund managers whether they have been finding a lot of bargains in emerging markets. What's most noteworthy is that three of the managers with the best longer-term records agree that the answer is no, bargains are not abounding by any means. While there were some nuances in their answers, as well as some dissent from other managers, the basic lesson from listening to these three is that investors need not think that emerging-markets stocks have suddenly become so cheap that they present a can't-miss opportunity.

I should point out that the managers we're referring to here all run broad international funds, not those that focus specifically on emerging markets or a specific region. The broader managers' opinions are more noteworthy than those of managers specifically focusing on emerging markets, in a sense, because the former have the most freedom to choose whether or not to invest in Taiwan, Brazil, India, or any other emerging market. Keep in mind that even though the managers do speak in general terms at times, they are not making calls on the direction of emerging markets as a whole; rather, their opinions are based on their evaluations of individual companies.

Rudolph-Riad Younes, head of international equities at Julius Baer and manager of the US-sold Julius Baer International Equity and Julius Baer International Equity II has traditionally owned much larger emerging-markets stakes than the vast majority of his peers, so he might have been expected to dive in even deeper during the downturn. No way. While he did do a little buying in Central Europe, where he has long had the bulk of his emerging-markets exposure, he didn't do anything drastic there. (And it's worth noting that he doesn't necessarily consider those to be emerging markets as far as their risk profiles anymore, given their membership of the European Union and other factors.) Nor was Younes biting on India, a market he has practically avoided in recent years, in contrast with many rivals who've made it one of their favourite emerging markets. Although the main India index dropped more than 25% during the May/June swoon, Younes said the decline had not been deep enough to provide him with any compelling opportunities.

Meanwhile, in Turkey, a favourite of Younes but few others, he had cut the fund's weighting from about 6% to about 2% prior to the slide (a fortunate move because that country was hit harder than just about any other), and he says it's now at about 1%. There, along with valuations, his concerns centred on macroeconomic issues specific to that country.

It has been a similar story with David Herro of Oakmark International. Herro has often delved deeply into emerging markets; one example occurred after the Asian currency crisis of 1997, but that's far from the only occasion he's owned much more than the norm in emerging markets. But in recent years he has been doing most of his buying in the big developed markets; as a result, the fund's emerging-market stake had dropped substantially. And, like Younes, he recently told us he was not tempted to jump in during the decline. In general, he said, prices would have to fall much further in emerging markets for many stocks to become appealing to him.

A third manager with a fine long-term record who has taken the same stance is Gilman Gunn of Evergreen International Equity. Unlike the first two, Gunn has never been one to load up on stocks from emerging markets, but he hasn't been averse to owning them, either, when he's liked the company and the price. And he, too, says he hasn't been making any particularly noteworthy buys in emerging markets even after the decline--partly because he fears an economic downturn in the United States, which can have especially negative effects on those markets.

That's not to say no managers are buying in emerging markets. One manager who specifically took advantage of the price drop was Pamela Holding of Putnam International Growth & Income, who added back to the Petrobras stake she had sold down earlier in the year, as well as stocks in Korea and elsewhere. Interestingly, her colleague at Putnam, Joe Joseph of small-cap focused Putnam International Capital Opportunities, is in the opposite camp. He says prices have not come down nearly enough to provide a lot of enticing opportunities in emerging markets.

If the general tone of the managers discussed here is on the mark, there's no need to feel you must jump into an emerging-markets fund or add heavily to one you already own for fear of missing the chance of a lifetime. (Supporting the managers' point, it's worth noting that even with the recent slide taken into account, the average emerging-markets fund has still provided a 26.6% average annualized gain for the trailing three years through July 26.) In fact, there's a good argument that most investors, rather than trying to determine the best times to own such securities, are better served by owning broad international funds for the long term and thus letting their managers adjust their emerging-markets weightings based on their own--typically stock-by-stock--evaluations.