How to Play Emerging Markets on the Cheap

Whether you want to jump onto highflying emerging markets at these levels is up to you.

But you have to figure it's better to buy at a discount than it is to pay full price.

Who wants to pay full price?

It's been several months since I first wrote here that there was an effective sale going on in closed-end funds that invest in China and other emerging markets. Since then, those markets have skyrocketed -- but the markdowns on the funds have actually widened.

It's possible it's an early warning sign of turbulence ahead in those markets. Or, it could just be a fantastic bargain. But right now you can buy a $10,000 professionally managed portfolio of emerging-market stocks and bonds for less than $8,900.

You have to like that 11.5% discount. Emerging markets may be in a bubble, but that markdown sure improves your odds.

Closed-end funds are pooled investment vehicles much like traditional, open-ended mutual funds. The difference is that they do not issue new units when investors put in money. Instead, they issue a fixed number of shares when they launch, and investors who want to get in or out have to buy or sell those shares on the stock exchange, just as they would shares in General Electric ( GE) or Google ( GOOG).

To watch Brittany Umar's video take of this column, click here .

The result? Unlike ordinary mutual funds, closed-end funds often see their share price move independently from the value of their underlying assets. The investment managers could be shooting out the lights running the money, but if U.S. investors are looking elsewhere, the shares of the fund could fall behind.

And that's where we are now.

Hong Kong's Hang Seng Index has rocketed 15% so far this year and is hitting all-time highs.

It's tough to beat a bull market, but Hong Kong-focused ( GCH) Greater China Fund (GCH), one of the granddaddies of the closed-end business, is doing it. The fund's net assets per share have soared a stunning 44% since Jan. 1, to $35.18 from $24.50.

Great news for investors, yes?

Umm, not exactly. The shares -- as opposed to the assets -- are actually down 1.7% for the year.

Part of the reason? Fewer U.S. investors want them. Some people are nervous about Asia. Some speculators are using closed-end funds like this one to go short on China, betting against the market. And finally, the funds are suffering from competition. In the last year, a lot of other emerging-market funds have been launched to compete for investors' dollars.

"They've started to trade at big discounts," agrees Larry Glazer, portfolio manager at Mayflower Advisers in Boston. "Part of it is that there's been a big issuance of emerging-market ETFs, and emerging-market funds have had net outflows up until this month."

As a result, shares in the Greater China Fund are now selling for 12% less than the value of their underlying assets. You're buying a booming stock market on the cheap.

And this fund is not alone.

The table below lists 12 emerging-market equity funds and their current discounts. It also lists two emerging-market debt funds, their discounts and their yields.


Fire Sale in Emerging Markets
Discounts to net asset value per share, as of July 13
Fund Name Ticker Discount % Yield %
China Fund CHN 15.5 n/a
Mexico Fund MXF 14.3 n/a
Central Europe & Russia CEE 13.3 n/a
Greater China GCH 12 n/a
Latin American Equity LAQ 11.6 n/a
Singapore Fund SGF 11.4 n/a
Asia-Pacific Fund APF 11.3 n/a
India Fund IFN 11.2 n/a
Templeton Dragon TDF 11.2 n/a
Malaysia Fund MAY 9.5 n/a
Taiwan Fund TWN 9.4 n/a
Korea Fund KF 7.8 n/a
Western Asset Emerging Markets Debt ESD 12.7 6.8
Morgan Stanley Emerging Markets Debt MSD 10.1 6.1
Source: Nuveen Investments

The average discount for the 14 funds is 11.5%. In other words, you could buy a $10,000 portfolio in these markets by investing less than $8,900 and spreading it equally across these funds. And these are actively managed portfolios, not simple index funds.

While it's true that active investment managers struggle to add value in a mature market like the U.S., they can add a lot more in the riskier parts of Asia and South America. Most exchange-traded funds that invest in emerging markets use an indexing approach.

One caveat: Even in the best of times, closed-end funds usually trade for a modest discount to net assets. And sometimes larger discounts can persist for years. If you buy a fund for 10% off you could end up selling it for 10% off, or more. Nonetheless, the current discount puts the odds on your side.

Larry Glazer says that while emerging markets may look stretched in many instances, most long-term investors are going to want to keep at least 2% to 5% in emerging markets "because that's where the growth is. And if you're looking to invest in these markets for real, these funds are the way to do it."

In keeping with TSC's editorial policy, Brett Arends doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Arends takes a critical look inside mutual funds and the personal finance industry in a twice-weekly column that ranges from investment advice for the general reader to the industry's latest scoop. Prior to joining TheStreet.com in 2006, he worked for more than two years at the Boston Herald, where he revived the paper's well-known 'On State Street' finance column and was part of a team that won two SABEW awards in 2005. He had previously written for the Daily Telegraph and Daily Mail newspapers in London, the magazine Private Eye, and for Global Agenda, the official magazine of the World Economic Summit in Davos, Switzerland. Arends has also written a book on sports 'futures' betting.

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