First-quarter results challenge conventional thinking.
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By Gregg Wolper | 04-01-08 | 06:00 AM | Email Article

"Decoupling" is the latest financial buzzword. It does not refer to the breakup of a Hollywood pair. Think less glamour, but more impact. As with much investment jargon, it can mean different things at different times--but typically it's heard when commentators debate whether emerging markets can maintain their strength as the U.S. economy falters. In other words, just because the United States and emerging markets rose together, they need not decline together.

Gregg Wolper, Ph.D., is a senior analyst covering active strategies on Morningstar’s manager research team.

Of course, investors hope that the stock markets would follow suit. So those who believe that emerging markets have "decoupled" from the U.S. have a reason to remain bullish on those markets even as America's economic news remains gloomy. Those who disagree say the gloom will spread.

It's not clear, though, that the issue is worth debating. For the concept rests on a questionable premise: that there's a coherent entity called "emerging markets." In fact, looking at the data as 2008's first quarter winds to an end, it seems that emerging markets did decouple--from one another. That's not the first time this has happened, either.

The good news: This means that mutual fund investors need not concern themselves with the latest argument bouncing around in financial circles. More important, if this development is lasting, it can ease the task of investing. It would offer an incentive simply to entrust your international money to broad-based funds run by talented managers who can invest wherever they spot the best opportunities, rather than you shouldering the burden of trying to forecast emerging-markets trends and then fine-tuning your exposure to them.

No Kick for the IC in BRIC
After astounding rallies in recent years--during which their gains surpassed even the strong returns posted by other emerging markets--the two giants, India and China, have fallen hard in the first quarter. And, as a result, the worst-performing international funds are those that focus on one or the other. For the year to date through March 27, the cellar-dweller is Oberweis China Opportunities , down 36%. The list of China and India funds with losses deeper than 20% is long, helping push the Pacific/Asia ex-Japan category average to a 21.3% loss.

But the diversified emerging-markets category hasn't suffered nearly as much. It has lost 11.5%, just 2 percentage points more than the core foreign large-blend category, whose funds focus overwhelmingly on developed markets. Many diversified emerging-markets funds have held their losses to the single digits.

How is that possible, given that the two markets that had provided much of the fuel for the prior years' emerging-markets rallies each have plunged more than 20% this year? The answer: Some emerging markets performed far better than China and India in the first quarter. Most notably, Mexico, Brazil, and Taiwan--all of which play important roles in most emerging-markets portfolios--have (for different reasons) posted only small losses or have even amassed gains. Other emerging markets land somewhere between those extremes.

As a result, it's hard to say how "emerging markets" are performing so far this year--or to determine whether they, as a group, have "decoupled" from the U.S. One has to wonder how much longer either will be a meaningful question. In fact, as discussed in a previous Fund Spy column, many investment professionals already divide the emerging-markets universe into several different tiers, depending on each individual country's level of development or risk. In fact, you can't even get investment professionals to agree on whether South Korea or Israel currently are emerging markets. Rudolph-Riad Younes, longtime manager of Julius Baer's international funds, doesn't think Poland, Hungary, or the Czech Republic belong in that camp. Most others, though, do.

The Impact on Investors
These figures shouldn't be overemphasized, as they reflect just three months of performance. But they do point to truths that can help simplify investment decisions. And this isn't an unusual occurrence. In fact, China's market wasn't even joining in on the raging rally in other emerging markets until late 2005 or early 2006. Similarly, despite widespread fears, Argentina's financial collapse a few years ago did not have a substanial impact on other emerging markets.

The developments could make investing easier. In particular, if countries generally considered to be emerging markets continue to differ from one another in performance, you could reduce your concern about your overall "emerging-markets weighting." Instead, you can simply let managers of broad-based international funds invest where they feel it most appropriate at the time.

In addition, these trends render the thorny "decoupling" issue moot. If you aren't allocating a specific amount of money to "emerging markets" as a group, you don't have to decide how that group will or won't react to U.S. economic trends. With so many other decisions to make these days, we can all benefit from having one less issue to resolve.

 

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Gregg Wolper does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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Morningstar - 2008/04/01 - Is a Key International-Investing Debate Off the Mark? - <a href="http://www.morningstar.com/articles/author/13-gregg-wolper.aspx">Gregg Wolper</a>
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