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Hunting for a Smoother Ride in Rough Emerging Markets

NEW YORK (TheStreet) -- Emerging markets have taken investors on a rough ride. During the past three years, emerging markets mutual funds lost 1.7% annually, while the S&P 500 gained 14.8%. Emerging market index funds did poorly: Vanguard Emerging Markets Stock Index Fund (VEIEX) was down a total of 14.7% over the last three years.

After this weak showing, many markets now sell at modest prices. The portfolio of the average emerging markets fund has a price-to-earnings ratio of 13, compared to 19 for the S&P 500. But before you try bargain shopping, keep in mind that many markets could remain choppy. In the past year, countries in Latin America and Asia have been plagued by weakening currencies and slowing economies. Vladimir Putin's move into Crimea added an extra note of uncertainty.

To limit risks, consider funds with track records for delivering relatively steady results in the difficult markets. Solid choices include Amana Developing World (AMDWX), Brandes Emerging Markets (BEMAX) and Virtus Emerging Markets Opportunities (HEMZX). All three funds have used distinctive strategies to excel during the downturns of recent years.

Virtus Emerging Markets ranks as one of the least risky options. The fund outdid 98% of peers in 2011, a year when fears about slowing growth in China sent emerging markets tumbling. During the past five years, Virtus returned 16.5% annually, surpassing its average peer by 3 percentage points.

The Virtus portfolio managers avoid trouble by focusing on very high quality stocks. Holdings must have high returns on equity, little debt and dominant market shares. The managers hold few energy companies, which could produce erratic profits as global markets change. Instead, Virtus prefers champion consumer stocks that can deliver increasing earnings year after year.

Holdings include Ambev (ABEV), a dominant beer distributor in Brazil. "Beer sales are growing rapidly as more consumers enter the middle class," says Peter Newell, managing director of Vontobel Asset Management, which oversees the Virtus fund.

Amana aims to follow Islamic law, which frowns on money lending and speculating. To comply with the rules, portfolio manager Nick Kaiser avoids most financial stocks and shies away from companies with heavy debt burdens. He focuses on growing businesses with strong balance sheets.

Once Kaiser buys, he rarely sells. Amana only turns over 4% of its portfolio annually, compared to 77% for the average emerging markets fund. During the past three years, the fund lost 0.2% annually, outdoing 73% of peers.

A holding is IOI (IOIOF), a Malaysian maker of palm oil and soap. For extra protection, Kaiser sometimes takes Western blue chips that derive much of their sales from the emerging markets. Such rock-solid companies tend to be steady in downturns. A holding is Colgate-Palmolive (CL). "They are growing by selling a lot of toothbrushes in Latin America," says Kaiser.

Brandes Emerging Markets follows a diehard value strategy. The managers steer away from hot markets and highflying stocks. During the past three years, Brandes lost 0.3% annually, outdoing 72% of peers. The fund recently increased its allocation to Russia as shares fell because of the Ukraine crisis. Portfolio manager Louis Lau concedes that Russia could slip into a recession if the West intensifies sanctions. But he says that the country has $500 billion in foreign reserves, enough cash to cover debts and the costs of imports. "Russia should be pretty resilient for the short term," he says.

Lau says that major Russian energy producers trade for multiples of two to four times earnings, well below the double-digit figures of U.S. competitors. His holdings include gas giant Gazprom (OGZPY) and oil producer Lukoil (LUKOY). "These companies pay good dividends and have lots of cash," Lau says.

A new fund with an intriguing approach is AllianceBernstein Emerging Markets Multi-Asset (ABAEX). The portfolio managers hold a mix of stocks and bonds. The portfolio currently has 38% of assets in fixed income and the rest in equities. In a bull market, the fund could lag. But the bonds could help to diversify the portfolio in difficult times.

At the time of publication, the author held no positions in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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