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These Foreign Funds Are Hungry for Emerging Markets

Quite a few diversified stock funds have significant exposure to the booming developing world.

David Kathman, 10/22/2010

Emerging markets have been hot lately. The developed markets of the United States and Europe are recovering slowly from the Great Recession, thanks to heavy debt loads and continuing uncertainty. Emerging markets such as China, India, and Brazil have been generating most of the world economy's growth in recent years, a trend that many expect will become even more pronounced going forward. The U.S. Federal Reserve's expansive monetary policy, designed to boost the sluggish U.S. economy, has had a side effect of stoking the emerging-markets boom.

Investors have reacted by pouring money into emerging-market investments, with much of that money coming from traditional core asset classes. Through the first nine months of 2010, emerging-markets stock and bond mutual funds have garnered net inflows of nearly $30 billion, while domestic large-cap stock funds have had net outflows of more than $50 billion, with most of that coming from large-growth funds. Morningstar recently introduced a new China Region category because of the proliferation of China funds.

Of course, the popularity of emerging markets doesn't mean that they'll continue to do well--and could be seen as a contrarian indicator. Morningstar's annual "Buy the Unloved" study has found that fund categories with the biggest inflows in a given year tend to underperform over the following three to five years relative to categories with the biggest outflows. China's recent decision to raise interest rates to slow growth spooked investors and illustrates the risks involved. Nevertheless, there's no shortage of smart investors betting on the long-term potential of emerging markets.

The most direct way for U.S.-based investors to get access to these markets is through an emerging-markets mutual fund, but quite a few diversified stock funds have significant emerging-markets exposure. Among funds in the diversified foreign-stock categories (foreign large growth, foreign large blend, etc.) with more than $1 billion in assets, the four below have the highest percentage of their portfolio in emerging-market stocks. (The percentages below use Morningstar's definition of emerging markets, which does not include Taiwan and Korea.) All of these funds have healthy appetites for risk beyond just their emerging-markets stakes, which have helped them at times and hurt them at other times.

Oppenheimer International Small Company OSMAX
As of May 31, this fund had 39% of its equity assets in emerging markets, including top-10 holdings Anvil Mining (from the Democratic Republic of the Congo), Oriental Bank of Commerce (from India), Pacific Rubiales Energy (from Colombia), and Colossus Minerals (from Brazil). As those examples suggest, the emerging-markets exposure is only one aspect of manager Rohit Sah's aggressive strategy. He's willing to own micro-caps, which currently make up almost 10% of assets, and he makes big sector bets, with industrial and energy stocks currently taking up more than half the portfolio. That strategy has made this one of the most volatile funds in the foreign small/mid-growth category since Sah took over in 2004. In 2008 it lost two thirds of its value and ranked near the category's bottom, but in 2009 it rebounded to a 122% gain, among the best in the category.

Janus Overseas JAOSX
This $13 billion fund has been managed since 2001 by Brent Lynn, who has been more adventurous than his foreign large-growth category peers. Though he cut back the fund's emerging-markets exposure in the first half of this year due to valuation concerns, as of June 30, 2010, about 28% of the portfolio was still in emerging markets, versus 21% in Europe. That emerging-markets exposure includes the portfolio's second-largest holding, Indian conglomerate Reliance Industries, which Lynn likes for its growth prospects despite the stock's big runup since early 2009. The fund sports top-decile 10-year returns, but in 2008 it ranked in the category's bottom decile with a 53% loss.

Artio International Equity BJBIX
This fund's 28% emerging-markets stake (as of July 31, 2010) is just slightly below that of Janus Overseas, and it has a similarly strong 10-year record, but otherwise it's a rather different fund with a lower risk profile. Managers Rudolph-Riad Younes and Richard Pell (Morningstar's Foreign-Stock Fund Managers of the Year in 2002) have half the portfolio in western Europe and less than 10% in emerging Asia. Much of the fund's emerging-markets exposure comes from eastern Europe; its top holding as of July 31 was Czech bank Komercni Banka, and Sberbank of Russia was also in the top 10. Younes likes Russian stocks right now for their cheap valuations and relatively low leverage.

William Blair International Growth WBIGX
This is another fund with a longtime manager, George Greig, whose willingness to take risks has led to a good long-term record with some short-term bumps along the way. Its 27% emerging-markets stake (as of Aug. 31) is fairly staid, as such things go; most of these stocks are from Asia and Latin America, where the fund's biggest holdings are Chinese oil giant CNOOC and Mexican telecom giant America Movil AMX. Still, that emerging-markets stake did contribute to the fund's tough 52% loss in 2008, as well as its 42% gain in the 2009 rebound.

David Kathman, CFA, is a fund analyst with Morningstar.  

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