If there’s one truism I’ve found during my years in the investing field – which date back to the 1980s – it’s the fact that everything is cyclical.
What runs hot will inevitably turn cold in a few years, and vice versa.
This reality is beautifully illustrated in this following periodic table of asset class returns. The table appeared in The Wall Street Journal courtesy of Budros, Ruhlin & Roe in Columbus, Ohio.
The firm’s advisors use it to explain to clients why diversification is necessary. It also reinforces my contrarian bent. For instance, I’m not at all interested in the red-hot biotech and tech industries right now.
Instead, I’m looking at a sector everyone is avoiding like the plague… emerging markets.
I’ve been investing in emerging markets since the 1980s. Today, I’d like to share some tips on how to pick the best emerging market funds – and, just as importantly, how to avoid the losers.
Tip #1: DON’T Use an Index Fund
Index funds seriously narrow your investing universe. That’s true here in the United States, as well, but it’s really bad in emerging markets.
Data from the Institute of International Finance brings home my point. Only about $7.5 trillion of the $24.7 trillion universe of emerging market stocks is contained in the various indices run by J.P. Morgan, MSCI, and others. The rest is simply ignored.
I don’t know about you, but I don’t want to pretend that roughly 70% of emerging market stocks don’t exist. As I’ve said before, you don’t shop in just one aisle at the grocery store. Don’t do it in the stock market, either.
Tip #2: Don’t Invest in Closet Indexers
So now we’ve eliminated index funds. Next up is looking at the top 10 positions in any fund you’re considering.
The fund manager is a closet indexer. They’re only interested in matching the index by which they’re judged, rather than actually making money for the fund’s shareholders.
Tip #3: Avoid Funds That Over-Invest in Two Sectors
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Finally, it’s important to look at the sector breakdown of a fund. In far too many cases, these funds are over-invested in just two sectors.
If you see 50% or more invested into financials and technology, skip over this fund. This fund manager doesn’t understand emerging markets and may be confused into thinking that they’re investing in the U.S. market.
Indeed, these two sectors are loved by U.S. fund managers, and that fascination is one reason I believe most emerging market funds have performed so badly.
What to Look For
Now that we know what to avoid, let’s figure out what we should be looking for in an emerging market fund.
I’m a great believer that people are people, no matter where they live. And all people aspire to better their lives and those of their children. For me, that means investing in funds that emphasize the growing consumer class in developing economies.
Look at China, for instance. It’s moving away from an industrial economy toward a consumer economy. Just as we no longer consider U.S. Steel Corp. (X) a bellwether for the U.S. economy, we probably shouldn’t count on industrials to perform that role in China much longer, either.
And that means you don’t want to own the usual Chinese names.
Instead, you want to own something like the South Korean cosmetics company AmorePacific Corp. (AMRPF). Its sales and revenues are soaring thanks to Chinese demand, which is boosting its stock.
Another option is a frontier market stock like Safaricom Ltd. (SCOM), Kenya’s dominant telecom firm. Kenyans have the same mobile phone addiction as everyone else, and the safety valve is that it’s 40% owned by telecom giant Vodafone Group Plc (VOD).
In closing, stick with funds that emphasize the growth of consumerism in places like China. Companies like Apple Inc. (AAPL) are benefiting, and so will the myriad number of home-grown consumer companies in the emerging world.