Investors high on emerging markets, while analysts counsel caution

Investors are flocking to emerging markets with the anticipation of hefty returns, though analysts doubt that the performance will last.

According to research firm Lipper Inc. of New York, investors poured $12.1 billion into emerging markets in the first six months of 2009, a turnaround from the $2.5 billion in net inflows in the comparable time period last year.

Investors started putting more money back into emerging markets this year because the sector started showing some signs of life in March, said Jeff Tjornehoj, senior research analyst at Lipper.

Emerging-markets funds lost 29.91% in 2008, China-region funds alone lost 52.71%, and Latin American funds lost 39.47%, according to Lipper.

This year has been a different story.

Emerging markets posted a 34.18% gain year-to-date through June 30, China-region funds had a return of 37.24%, and Latin America posted a 44.51% gain.

But those gains are not likely to continue, Mr. Tjornehoj cautioned.

“It’s really difficult to maintain that torrid pace,” he said.

“I think you’ve seen the bulk of the year’s returns already. We may add another 10% in the last six months of the year.”

Emerging markets are considered riskier because they open the investor up to political, currency and economic-instability risks, Mr. Tjornehoj said.

“That’s why they can get returns like this,” he said.

While the pace of gains may slow in the coming months, investors remain bullish on emerging markets, said Dina Ting, portfolio manager at iShares, the exchange traded fund business of Barclays Global Investors of San Francisco.

The firm offers more than a dozen emerging-markets ETFs.

“More investors consider emerging markets part of their core allocation,” Ms. Ting said.

“The typical risk associated is the political instability of the country. But there is the benefit of diversification. It will improve the overall portfolio.”

Investors are also looking for future growth, Ms. Ting said.

“In this recession, there is a higher likelihood that emerging markets will experience better outperformance than developed markets,” she said. “Countries like Brazil, China and India are still growing. In general, emerging markets have a healthier financial structure,” Ms. Ting said.

The big losses last year translated into a buying opportunity for some advisers.

“We increased exposure before the rally started and some just after it started,” said Drew Tignanelli, president of The Financial Consulate in Hunt Valley, Md., a 25-year-old firm that does not disclose its assets.

The firm’s typical portfolio has increased exposure to emerging markets to its current 25%, from 5%, just prior to the market downturn last fall, he said.

The firm is also more focused on locations such as Hong Kong, China, Singapore, Taiwan and Korea because they are more stable and have more potential for growth in the consumer market, Mr. Tignanelli said.

“Emerging markets are going to be the place to be in the next 10 years or so,” he said.

But not everyone is buying.

Sticking to an asset allocation model can mean selling emerging markets to re-balance portfolios, said Bill Houck, a financial planner with Modera Wealth Management of Old Tappan, N.J., which has $400 million in assets under management.

A typical client portfolio has a 5% to 7% allocation to emerging markets, he said. “As it goes up in value, we want to sell,” Mr. Houck said.

“We want to sell high. It’s part of the re-balancing process that we do every month,” Mr. Houck said.

Chasing trends is a losing game for investors, he said.

“When people start chasing investment flows, it’s usually a losing game when they see a run-up that’s already happened,” Mr. Houck said.

Still, emerging markets may have some advantages. “Commodities like gold and oil are leading the way [in the recovery], and that’s helped emerging markets, because they tend to be resource-rich,” Mr. Tjornehoj said.