Spooked Investors Slow to Follow the Pros Back Into Emerging Markets

But if strong returns continue, the money should eventually follow.
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Institutional investors are bullish on emerging Latin American and Asian economies. But despite a strong surge this year in emerging-markets mutual funds, individual investors are still too spooked to buy in.

"For clients, there's a crisis of confidence when it comes to emerging markets. People who might be interested have been burned off by losses in the past few years," says William Baldwin, a financial planner with

Pillar Financial Advisors

in Lexington, Mass.

Among 35 emerging-markets funds with a five-year record in fund-tracker

Morningstar's

database, not a single one has a positive return for that period. The average annual return over the past five years: -4.9%.

But with emerging-markets funds delivering an average return of 27.9% this year, the pros feel the worst is past. In a

BankBoston

survey of 150 institutional investors, released Monday, 77% say they believe Asian security prices will grow over the next year, and 53% say Latin American markets would follow suit. Half the investors polled say they are more confident in Latin American economies' stability than they were last year, and a whopping 72% say the same about Asian markets.

"Investors are saying they believe the emerging markets have pulled out of the storm and deserve their confidence again," says BankBoston President Henrique de Campos Meirelles.

Survey respondents say improved banking supervision and increased trade liberalization have brightened their view on Asia, while improved monetary stability and fiscal discipline have led to growing confidence in Latin America. Countries receiving top marks are Japan, Korea, Mexico and Brazil.

Mutual fund managers who invest overseas agree.

"I think the survey's findings are in line with what I'm seeing in those markets. Japan and Korea are moving along well, and Latin America is still cheap," says

Franklin Templeton's

Mark Mobius, who manages more than $12 billion in international investments, including the

(TEDMX) - Get Report

Templeton Developing Markets fund and the

(TEEMX)

Templeton Emerging Markets fund. Both funds have returned more than 20% this year.

Miren Etcheverry, portfolio manager of the

John Hancock International

and

(JHGAX)

Global funds, also agrees with the survey's findings, but believes there could be hiccups in the short term. To reduce volatility, she is investing in companies that are based in developed economies and that draw significant revenue from emerging-nation consumers. "We are doing little in emerging markets right now. An example of how we are investing there is a company like

Spain's

Telefonica

(TEF) - Get Report

, which draws significant revenue from Latin American customers."

Michael Donnelly, portfolio manager of the

(TWMIX) - Get Report

American Century Emerging Markets fund, sees opportunity in Asia among cost-competitive Korean and Indian software makers. But he is most bullish on Latin America. "Recessions in Chile, Peru and Brazil have played out, and as more credit is extended to these economies, we see they have legs to stand on, namely low-cost natural resources," he says.

Donnelly also sees strong returns for mining companies in Chile and Peru, steel makers in Brazil and Argentina, and oil-exporter Venezuela.

But even though emerging-markets funds have been trouncing U.S. stock funds this year, Etcheverry and many others don't think individual investors will develop an appetite for them anytime soon.

Indeed, emerging-markets mutual funds have suffered a net loss of $152.6 million in assets since Jan. 1, according to

Financial Research

of Boston. And that's on top of $654 million in net redemptions in 1988. (Figures include investment from institutions and individuals.) Total assets in emerging-markets funds are $17.3 billion.

"My clients aren't asking about emerging markets, so I focus international allocations in developed countries," says Bruce White, a Pasadena, Calif.-based private money manager. He notes that over the past year he has invested some clients' assets in Japanese stocks, earning enviable returns.

"Big money won't come into emerging-markets funds until the Net stocks cool off. Right now, people look at those

stocks and say, 'What do I need emerging markets for?'" says Templeton's Mobius, who believes the current growth in emerging markets will continue for three to five years.

But if Japan funds are any indication, investors will eventually warm up to emerging-markets funds if they continue producing above-average returns. Japan is not an emerging nation, though Japan funds have performed like emerging-markets funds over the past few years. But this year, they're up an average of 70% through Sept. 23, and fund flows are in the black by $1.8 billion so far this year.

"If one thing is true of mutual fund investors, it's that they will chase top-performing funds, assuming that those returns will continue," says Jim Folwell, a consultant at Boston-based fund researcher

Cerulli Associates

.

Financial planner Baldwin advises investors interested in emerging markets to limit their exposure to 5% of their assets or to choose a diversified equity fund where a professional international investor can move in and out of emerging markets opportunistically.