5 Emerging-Market Funds for Better Days

The Dow Jones Industrial Average fell below the 8,000 level this week. Given that this time last year that benchmark was topping out above 13,000, it's easy to see why the returns of so many mutual-fund categories have seemingly fallen off a cliff. And nowhere is that more apparent than in the emerging-markets space, where the average fund is down a whopping 64.6% in 2008, according to Lipper.

This has been a painful year for investors all around, and maybe more so for those who favored overseas offerings. Emerging markets -- typically the label attached to developing economies like Brazil, China, Korea, India and nations in Eastern Europe -- were recently the darlings of the investing world. Mutual funds focused on China returned over 50% a year in 2006 and 2007. Latin America funds were right behind that group. But the problems that have plagued the U.S. have seeped into those markets, too, and jittery investors have been fleeing ever since.

This week the SmartMoney.com fund screen focuses on this beleaguered category. Our Lipper database lists an initial universe of 446 emerging-markets funds. We excluded funds that charged a load and then searched for ones that had top-tier performance track records during the trailing three- and five-year time periods. We also looked for offerings that charged less than $150 a year for every $10,000 invested. Ultimately, we were left with five funds. They are listed on the table below.

Our fund screen is predicated on recommending decent funds for consideration in an investment portfolio. But every once in a while -- this week being a prime example -- we have a hard time putting our stamp of approval on anything that gets spit out of our screening tool. That's because it looks like the tough times being endured by emerging markets will continue well into 2009. We are all about being opportunistic when it comes to buying cheap stocks and funds. In this case, though, we think it pays to sit on the sidelines until at least some of the dust settles.

We have ample reason for making that statement. There are the usual caveats. Emerging markets feature geopolitical risks that are hard to predict. The companies headquartered there aren't always transparent. Country-specific funds, like those championed by the ETF world, can be extremely volatile and illiquid. However, our concerns run deeper than all that.

The prospects of emerging markets depend in large part on the developed world either making investments in those countries or exporting their goods or natural resources. Japan has officially entered into recession, and the U.S., Europe and the rest of the globe aren't far behind. It seems unlikely cash-strapped consumers will buy a flat-screen TV made in Asia when they're having trouble putting food on the table.

That scenario can be seen in the rise and subsequent fall of crude prices. Emerging markets like Russia and Brazil are closely linked to the global oil industry. When prices soar, as they did earlier this year when crude neared $150 a barrel, these countries prospered. But that high price translated into record tabs at gas pumps for consumers. They instantly cut back on driving and gas and oil demand ebbed. The per-barrel price has fallen by two-thirds lately and now sits at around $50. That hurts. Russia recently announced a bailout plan that could top $200 billion. It has also repeatedly been forced to stop the trading on its stock exchange because of plunging prices and volatility. That doesn't sound like a situation we'd be willing to dive into.

China is another prime example. The most important emerging market on the planet (if you can call it that any more) will probably see its economic growth fall to around 8% from low double digits. A few percentage points may not sound like a lot. In terms of GDP growth, though, it is a monumental amount. It appears the post-Olympic malaise many market watchers were predicting earlier this year has actually shown up.

Some of the troubles plaguing these markets can be chalked up to a trickle-down effect from the developed world and to some economic woes within the countries themselves. However, it can also be partly blamed on the transient nature of the opportunistic investors that have inhabited emerging-market funds the last few years. These investors jumped into these funds when times were good hoping to get a taste of some of the big returns the funds were kicking off. These investors have also been the first to flee when signs of trouble started appearing. Outflows can force managers to sell stocks they don't want to and it can trigger capital gains for the shareholders who stick around through thick and thin.

Maybe our biggest reason, though, for steering clear of emerging markets is that there are ample bargains here in the U.S. that could potentially yield big returns while exposing investors to less risk than overseas options. The S&P 500 index is trading at a seemingly cheap 12 times trailing earnings. No doubt there are plenty of bargains there that could rise 20%, 30% or 40% over the next few years.

This won’t be our take on emerging markets forever. We still believe in the idea that international and emerging-market funds can add good diversification to the typical investing portfolio. So if you are currently sitting on an emerging-markets position we would leave it static. Devote your hard-earned cash to other parts of your portfolio. You won't miss out on any rally. Remember, even generic international index funds have exposure to these markets or hold companies that sell into them and therefore will benefit from any rebound. When you start to see economic growth return we would then consider slowly building a position in one of the funds below.

The Criteria: The equity emerging-markets funds listed below are open to new investors, require a minimum investment under $5,000 and charge less than a 1.5% annual expense ratio. Their three- and five-year track records put them in the top 50% of their category. As usual, we did not include load funds on our list.

Fund Type = Emerging Markets
Annualized 3-Year Return (%) = Display Only
Rank in Classification (%) (3 year performance) <= 50
Annualized 5-Year Return (%) = Display Only
Rank in Classification (%) (5 year performance) <= 50
Expense Ratio <= 1.5%
Load Fund (type) = No Load
Minimum Initial Investment <= 5,000
Open to New Investors = Yes
Total Net Assets ($ millions) >= 50
Year-to-Date Return (%) = Display Only