Emerging- Market Funds Suffer Setback

By Jeremy Herron
Associated Press
Sunday, June 4, 2006

Investors who poured money into emerging-market mutual funds in the past two years may be a little uneasy after the funds declined sharply over the past month.

Fund analysts are not so worried. They say the downturn is only a correction in markets that are fundamentally strong. And, they say, while the investments are risky, emerging markets deserve a place in a long-term diversified portfolio.

After delivering a three-year return of more than 40 percent, emerging-market funds had a negative return of 8.41 percent in the past month, pulling the category's year-to-date return down to a still-hefty 10.23 percent, according to fund-tracker Morningstar Inc.

"The recent sell-off is not a sign of long-term trouble," said Arijit Dutta, a mutual fund analyst at Morningstar. "People were chasing performance, so, with so much cash going in, it is bound to cause the markets to overheat."

Emerging-market funds had cash inflows in the United States of $23 billion in the first quarter of 2006, equaling the total for all of 2005 and more than five times the level in 2004, according to Brad Durham, managing director at Emerging Portfolio Fund Research.

"They got ahead of themselves because of excessive liquidity," Durham said. "The market was due for a correction."

That came as a huge outflow -- $5 billion -- in the seven days ended May 24, Durham said.

Analysts say emerging-market funds are essential for long-term investors seeking growth. Julian Thompson, portfolio manager for RiverSource Emerging Markets Fund, recommends holding funds at 5 to 20 percent of a portfolio.

Dutta is less bullish. "We have been saying for more than a year to cut holdings in emerging markets to about 5 percent to 8 percent," he said. "If your portfolio has gotten out of balance because of the huge gains, then now would be a good time to take some chips off the table and put them somewhere else."

Dutta advised caution because the funds are by nature risky, targeting companies based in developing economies where volatility is high and the risk of an economic collapse is real. Remember the crises of the 1990s that swept Mexico, Asia, Russia and Brazil.

"Emerging markets do have a role to play, but it should be limited because of the volatility," Dutta said.

The funds typically hold stocks in 70 to 100 companies based primarily in those troubled areas, India and China. They also include smaller countries in Latin America, Eastern Europe and Africa.

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