Mark Dampier: Emerging markets a risk worth taking

The Analyst

This week I'm going to start by beating you over the head with facts. Emerging markets represent approximately 75 per cent of the global land mass and 80 per cent of its population. One in every five people in the world is Chinese and one in every six is Indian.

Emerging markets have over 90 per cent of the world's oil and gas reserves, 70 per cent of the coal and more than 60 per cent of copper, nickel and iron ore. Finally (if you are still with me) the combined imports to Brazil, Russia, India and China during the course of 2009 are estimated to surpass the US for the first time, signalling a trend of reducing the global economy's dependence on the US consumer. The combined investment potential of the sector is immense.

Emerging markets has been a favourite area of mine for a long time. In fact, when my son was born in 1990, I started a monthly savings plan in a leading emerging markets fund, which I am still doing today. I believe the current financial crisis has probably accelerated the transfer of wealth from West to East and, although they can be volatile, these economies should continue to prosper over the next 20 years or more.

The most obvious way to access these opportunities is through a fund such as Lazard Emerging Markets. The fund manager, James Donald, an American, remains bullish about the sector over the medium to long term. However, on a very short-term view, he is wary considering that emerging markets have risen a lot recently and could be due for a brief pull back – this seems like a sensible view to me.

Some readers will have noticed the Chinese market has made strong gains recently and the Russian market has been especially strong, roughly doubling in the last few months. This, of course, needs to be put in context – Russia had previously fallen around 80 per cent from its peak last year, so anyone investing at the top of the market still has sizeable losses.

This demonstrates the risk, volatility and potential reward of investing in this region. It takes a steady hand to invest successfully here.

The Lazard team approaches emerging markets from what is known as a 'bottom-up' view. In other words, they tend to seek out attractively valued companies with good potential growth first, and worry about country allocation afterwards.

The recent rally in emerging markets has been linked to a rise in commodity prices, indeed the two are pretty closely correlated. Remember that if you already have some commodity funds in your portfolio, you will effectively have some emerging market exposure by default.

The Lazard team has had a big overweight position in Russia, where they felt share valuations were just incredibly low. Even after rising so strongly they still look good long-term value. Interestingly, one area where the fund is currently underweight is China, with only one holding in the fund that represents 0.8 per cent of the portfolio. The reason for this is because Mr Donald cannot find compelling valuations at present and very few companies are sensitive to profitability, instead being more focused on gaining market share. He believes most of the long-term potential in these stocks is already being reflected in the price so there isn't as much profit to be had at the moment.

It is important that investors realise that emerging markets are higher risk and can be extremely volatile over the short term. However, those who can take a longer time horizons (particularly young people contributing to a personal pension) should be making contributions on a regular basis.

Saving monthly can help smooth out the fluctuations in the market and you won't need to worry every time the markets take a brief lurch downwards. In fact, this will often work in your favour and allow you to buy more units cheaply. Lazard has done a good job so far with its Emerging Markets fund and it is certainly one worth looking at.

Mark Dampier is the head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more information about the funds included in this column, visit www.h-l.co.uk/independent