The Meltdowns You Might Have Missed

The U.S. financial meltdown is dominating the news--and with good reason: The events of the past few weeks have been truly jarring. Everyone from small investors to experienced investment bankers is waking up each day wondering what unexpected and unpleasant headlines are awaiting them that morning.

We've provided extensive analysis of the crisis from multiple angles. But just as the constant coverage of a major hurricane on cable TV can crowd out other worthwhile stories, the attention paid to the ever-evolving U.S. financial meltdown has pushed other investment news to the side. We thought mutual fund investors might want to know what else has been going on.

Not that the news is happy. It turns out there are mutual fund meltdowns taking place right now that would be receiving far more notice if not for the monumental events at center stage. Most notable are the stunning declines in funds devoted to India, China, and Russia--funds that were all the rage not that long ago.

Reversals of Fortune
Prior to late 2007, emerging markets had been hot for years, even when compared with the rallies taking place in the United States and Western Europe. After posting a stunning 55% return in 2003, Morningstar's diversified emerging-markets category continued to handily beat nearly all of the U.S. and foreign Morningstar Style Box categories every year through 2007. And the most specialized funds--those that targeted either China, India, or Russia--were the superstars in the field. (Brazil, which some trend-chasing investment firms grouped with the first three as the "BRIC" club, won't feature here because unlike the others, it doesn't have an open-end mutual fund devoted solely to its market, though an ETF does exist.) Eaton Vance Greater India (ETGIX) gained 114% in 2003, 45% in 2005, and 55% in 2007--with hefty gains in between as well. The typical China fund roughly tripled in value between late 2005 and late 2007. ING Russia  gained more than 65% in three separate calendar years between 2003 and 2007.

Now the story is decidedly less pleasing. This year the markets in all three countries have plummeted. They haven't performed in lockstep, though, and have been affected by different factors. China's plunge started at the end of October last year and had much to do with concerns about specific government policies and about the outlook for some of the market's bigger companies. India held up until the beginning of 2008, and its decline owes partly to rising interest rates in that country. (The steep valuations in both markets also helped accelerate the declines once conditions worsened.) Russia, meanwhile, stayed strong much longer; only in late May of this year did it start to fall in earnest, when the decline in oil prices started taking its toll on that energy-heavy market. Then two other critical factors--renewed government interference in shareholder rights and the Russian war with Georgia--sent foreign investors scurrying and the Russian market into free fall.

The results are stark. Through September 25, the dedicated China and India funds have typically lost between 40% and 50% this year. The smaller number of Russia funds have losses of just under 40%.

The Same Old Story?
Of course, the idea that single-country funds targeting an emerging market might suffer huge losses is nothing new. It never hurts, though, to remind people of that fact. We know from experience that when the times are good--and they were very good for very long in these markets--many investors either persuade themselves the markets can rise forever ("it's different this time") or forget just how deep the reversals can be.

We're not saying you must stay away from such funds. In fact, long-time owners of these funds (the relatively few such funds that have decently long histories) still have hefty gains even after this crash. However, most people will not tolerate such painful losses well--and won't be getting in at the beginning, or even the middle, of the boom. If you're still convinced you want to own a single-country emerging-market fund, tread lightly.

Fund firms also should think twice before offering such funds. In this area we can see once again the fund industry's unfortunate habit of jumping on a hot trend and coming out with new funds to capitalize on it. While some of the funds that focus on these countries have been around since the 1990s, a substantial percentage came out between 2005 and mid-2008. Also unsurprisingly, the expense ratios on these funds tends to be high.

When many funds suddenly appear targeting a fairly narrow area that's in the midst of a stunning rally, your level of skepticism should be high. Sure, the story might be persuasive. But whether that makes owning a specific fund the right choice for you is an entirely different matter.