Emerging-Market Stock Funds Promise High Average Return

Poll sees this as top stock class for next five years; but be ready for bumps

Uneasy about investing in stocks in the United States after the recent market skid? Some analysts see emerging-market stocks as an alternative for a portion of your assets.

The consensus of experts from 41 Wall Street firms is that these stocks will be the top-performing class of stocks over the next five years. Polled by KPMG Peat Marwick LLP in New York, these experts' average prediction was that non-US stocks in emerging markets would earn a 13.7 percent annualized return, compared with 11.3 percent for non-US stocks in developed markets, 10.7 percent for US small companies, and 9.1 percent for large US firms.

The hefty return reflects the fast economic growth rates in many developing nations such as South Korea, Malaysia, Thailand, Taiwan, and the Philippines.

Time frames are crucial when buying into emerging markets. If you are a long-term investor, selected nations look "promising," says Ian King, director of the emerging-markets portfolio at IDS International in London. But, if you are investing for the short haul, five years or less, then these stocks can present numerous political and economic snags, Mr. King adds. One is interest rates: When short-term rates rise in the US, developing nations can experience large run-ups in borrowing costs, hurting equity prices. The US Federal Reserve might boost rates in the next few weeks.

King says US investors should have only about 3 percent of their total assets in emerging-market equities.

He suggests investing on a country-by-country basis. Latin American economies posted steamy returns through June (up over 15 percent, according to IDS). But that region is "very sensitive" to US interest rates, King says. Eastern European markets, which have also done well of late, are far less sensitive.

Emerging markets turned in spectacular gains in the late 1980s and early 1990s. But the ride can be wild.

The main emerging-market index, that of Morgan Stanley Capital International in New York, rose 3.4 percent during the first quarter, compared with 2.5 percent for developed markets.

US investors poured $22.2 billion into overseas stocks during the first quarter of 1996, higher even than the $21.6 billion in the third quarter of 1995, according to the Securities Industry Association in New York. Of the first-quarter total, $5 billion went to emerging-market countries; another $2 billion went to Latin America, which many analysts also consider an "emerging" sector. By comparison, overseas investors bought $3.7 billion worth of US stocks during the quarter.

Most market experts say the best way to invest in emerging-market stocks is through mutual funds, which provide instant diversification. But many of these funds took a hit during the US stock-market debacle in July, says Andrew Lohmeier, an analyst at Morningstar Inc., a financial information firm in Chicago.

For example, the Vanguard International Equity Index Fund, Emerging Markets Portfolio, opened yesterday at $11.59 per share, compared with $12.33 at the end of June. The index fund's return for the year, through June, was 14.9 percent; now it is 7.9 percent. And Templeton Developing Markets Fund had a value of $14.22 per share yesterday, down from $15.02 at the end of June. Still, it is up 10.2 percent for the year so far.

Because of such volatility, many experts remain wary about committing much money to overseas issues.

"People who go offshore for their main investing" are looking for trouble, says Thomas Byrne, director of research at Individual Investor magazine in New York. "We have the greatest capital structure in the world in the United States, with over 9,000 publicly traded companies. We have extensive securities laws to protect investors. We have detailed accounting laws." Mr. Byrne says "accounting and legal protections" vary from nation to nation abroad, and in some developing nations are dubious.

Investing in emerging-market nations is also guesswork to a large extent, Byrne says. He notes that in the past 20 years, no single nation has repeated twice in succession as the top overseas equities market.

"If you do invest abroad," Byrne suggests doing so "through a reputable and well-established mutual fund." He recommends you have no more than 10 to 15 percent of your portfolio in overseas stocks, of which a small fraction would be in emerging markets. An alternative to investing abroad, he says, is finding "emerging-growth companies in the US" - small firms with fast-rising earnings.

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