The Furious Comeback of Emerging Markets

Blame it on emerging markets. That seemed to be a fair line to take not too long ago, when any systemic financial crisis could usually be traced back to a series of debacles in developing markets. The current global financial crisis, however, originated right here in the United States. And yet, emerging markets were among the most brutally punished as investors indiscriminately fled all risky assets.

Many are perhaps realizing last year's verdict was too harsh. Morningstar's diversified emerging markets, Latin America, and Pacific/Asia ex-Japan categories are up between 46% and 63%, which are by far the best results among all domestic and foreign categories.

We invited fund managers Rusty Johnson, Arjun Divecha, and Andrew Foster to participate in a conversation via conference call on Aug. 3, so they could share their insights into emerging markets' investing merits and drawbacks. These veteran managers have tracked many powerful changes in this asset class over the years, and shareholders at their funds have benefitted from the investing themes they have sniffed out.

Johnson is the lead manager of Harding Loevner Emerging Markets HLEMX as well as a comanager of Harding Loevner Frontier Emerging Markets HLFMX. His high-quality growth strategy has delivered strong long-term returns with relatively moderate volatility during his 11-year tenure at Harding Loevner Emerging Markets. Divecha has led the charge at GMO Emerging Markets III GMOEX for more than 15 years. His mostly quantitative--but augmented by fundamental analysis--approach has produced strong results during his tenure. Divecha was recently promoted to be the chairman of the firm, after Jeremy Grantham, GMO's famously contrarian market prognosticator, stepped down from that role. Foster is the skipper at Matthews Asian Growth and Income MACSX. He is among the thought leaders at Matthews' formidable group of Asia experts. The firmwide focus on domestic growth and lesser-known stocks gives investors at Matthews funds a distinct, off-the-beaten-track look at Asian markets.

The conversation has been edited for clarity and length.

Arijit Dutta: About a year ago, there was much talk about decoupling and that emerging markets would escape the crisis. The crisis didn't originate in emerging markets, people argued, and emerging markets now had their own growth engines. In late 2008, both those theories were shot to hell. Yet now it seems like the decoupling argument is arising again. What are your thoughts on this topic?

Arjun Divecha: First of all, the idea of using a single concept called decoupling to encapsulate a whole range of complex issues is very narrow-minded. There is not a single dimension to emerging markets.

Having said that, the way I think of most emerging economies is that they are like a boat with two engines. One engine is export-driven; the other engine is domestic consumption. Clearly, a decoupling to the West and developed markets cannot happen on the export side. If developed markets do not recover, demand does not recover, and the export engine is going to stay broken for a while. On the other hand, we have the domestic consumption. This is where you've seen the new decoupling that people recently have been talking about. Domestic demand and consumption have been stimulated through massive fiscal and monetary spending. It is working as you would expect it to, because for most of these countries, this is not a structural crisis; it is a cyclical crisis. The United States and developed markets, for the most part, have had a structural crisis; they will have to change their financial systems coming out of this. That's not true for emerging markets.