Emerging markets tend to deliver higher returns over time for investors than the U.S. equity market, but at the cost of much more uncertainty and volatility. As bad as the 2008 collapse was for Wall Street, it was far worse for most smaller markets where losses were nearly twice the U.S. declines.
One top fund manager says he has found a way to lessen the risk of investing in far-flung places: Buy local companies that supply consumer needs in the developing world, and you will avoid the "external vulnerabilities" but still get the high rate of growth.
"The consumer is the essence of the emerging-market story," says Lewis Kaufman, who manages the Thornburg Developing World Fund. "It's a very long-tail story that requires patience. There will be corrections, but as long as you focus on the countries where domestic demand is rising over the long term, you will be okay. You don't want to invest too much in countries exporting to the U.S. and Europe."
[Read: Why Was Dow 14,000 One of the Toughest Milestones Ever for Stocks?]
Emerging markets were mostly stronger last year, and investors began putting cash into international funds at the highest level in years. But in December, the developing-world markets were grounded by worries over the U.S. budget showdown, the European Union's Cyprus financial crisis, a slowdown in China and, most recently, a drop in gold and other commodities. By sticking to its consumer-focus strategy, Thornburg Developing World gained 8 percent from the start of December to mid-April. The iShares MSCI Emerging Market (EEM) index fell 3.5 percent over that span. The $400 million Thornburg fund's publicly traded 'C' share class (symbol:THDCX) has averaged a 9.9 percent return since inception three years ago, versus an annualized 2.3 percent for the MSCI.
Kaufman says the companies in the MSCI Emerging Markets index have more exposure to big commodity producers and China. Among the MSCI's top 10 holdings are energy giants including Brazil's Petrobras and Russia's Gazprom, which are big components along with three large Chinese companies. Energy, industry and materials make up more than a quarter of the total and together are the largest group. The Thornburg fund has half its assets in consumer stocks of companies operating in the developing world.
"Our fund is actually more "emerging" than the [MSCI] index," says Kaufman. "The MSCI is very materials-heavy."
[Read: 5 Lessons from the Last Stock Crash.]
Kaufman looks for companies with solid financial underpinnings, low debt and a strong base of consumer demand that can generate earnings. He looks for them in economies large enough to support a mass market for consumers, citing larger developing countries like Indonesia or Thailand. He prefers countries whose currencies are not strongly affected by outside factors, so he has not been a big investor in Europe's fringe EU markets like Cyprus and Greece.
His fund lists a large position in Puregold Price Club Inc, a Philippines-based hypermarket retailer that has grown steadily as the local economy has expanded at rate of over 6 percent. Another is Credicorp Ltd, Peru's largest diversified financial company in an economy also growing at better than 6 percent. Kaufman also invests part (just over 10 percent) of his fund in U.S.-based companies that are net sellers to the emerging consumer markets. Qualcomm, which sells mobile telephone technology widely as the technology standard for many developing countries, is one such holding.
Morningstar, Lipper and U.S. News give the Thornburg fund top ratings for both returns and low risk in the category of emerging market funds. But even the most risk-averse of such funds can experience volatility. Thornburg Developing World has had double-digital annual losses and gains in the three-year history of the fund.
One drawback in assessing the fund's prospects is the relatively short three-year history for measuring its performance. And Kaufman himself concedes that his fund had the luck of good timing to start in 2009 when emerging markets were making their post-crash lows. The markets have been positive, on balance, since that time.
"You have to take a long-term view to be in emerging markets, and they are not for everybody," Kaufman says. His own fund has gyrated through double-digit gains two of its years and a double-digit loss for one year. In any given year, the markets may be up or down. "The long-term outlook for at least some emerging markets is bright. It's not bright for all, but it's bright for many."
More From US News & World Report
- 7 Mutual Funds That Make Huge Bets
- Why Budget Woes and Cyprus Didn't Faze the Market
- Don't Miss the Big Change in Portfolio Rebalancing
- Mutual Funds
- Emerging markets