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Emerging-Market Funds Unbowed by Crisis

NEW YORK (TheStreet) -- With investors fretting about the European debt crisis, foreign mutual funds have sunk.

Japan funds dropped 6.8% during the past month, and European funds declined 4.5%, according to Morningstar. Among the most resilient were diversified emerging markets funds, which dropped 3.7%.

The outperformance by emerging markets was noteworthy. In the past, stocks in Latin America and Asia sometimes collapsed at the first sign of trouble in the developed world. As investors lost their appetite for risk, they would stampede out of the emerging markets.

But now the picture has changed. At a time when the U.S. and other developed economies are plagued with debt burdens, many governments in the emerging markets are on sound footing. The public debt of Chile is equal to 9% of the country's gross domestic product. The figure is 192% for Japan and 115% for Italy.

"The emerging markets now seem less risky than they did a few years ago," says Howard Schwab, manager of Driehaus Emerging Markets Growth (DREGX). "I would much rather hold sovereign bonds from Indonesia or Brazil instead of bonds from the Japanese or Europeans."

Because of the debt burdens, growth in the developed markets is likely to remain sluggish for years. But the outlook for emerging markets is considerably brighter. With hundreds of millions of people leaving impoverished villages and taking urban jobs, economies in Asia and Latin America are reporting strong growth, says Schwab.

"In the United States, a consumer-products company might increase earnings at a single-digit annual rate," he says. "In the emerging markets, you can find straightforward consumer businesses that will increase earnings 40% a year for the next five years."

Despite their superior growth, emerging-market stocks are cheap compared with their counterparts in the developed world, says Steve Cao, a manager of Invesco Developing Markets (GTDDX). Based on earnings estimates for the next 12 months, the price-to-earnings ratio for emerging markets is 10.5, says Cao. That is below the historical average of 12. Developed markets currently sell for a multiple of 12, Cao says. Besides offering strong growth potential, emerging-market stocks also pay a dividend yield of 3%, compared with 2% for the S&P 500.

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