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Cautionary tale emerges from Mexico

BAD though you may have thought the recession in Britain to have been, spare a thought for Mexico. Its thriving economy has come close to collapse, its currency has fallen through the floor, its stock market has nosedived and whole swaths of industry are shutting down.

To most outsiders the crisis came out of the blue, a good illustration of the risks of emerging-markets investment. Anyone holding Mexican shares has watched them climb spectacularly for three years only to plunge equally impressively in three months.

This is not an argument against all emerging markets investments. The economies of most developing countries, now classed as emerging markets, are, after all, growing at more than 6 per cent a year, compared with around 3 per cent for most of the developed world. Mexico's plight is simply a warning to treat emerging markets with extreme caution.

"We haven't had a huge exodus of investors because most people believe that the long-term growth story of emerging markets is still intact," said Steve Bates, manager of Robert Fleming's Emerging Markets Fund.

Investors in emerging markets have to take a long-term view - say, three years or more where possible. This helps smooth out the volatility. The Mexican crisis may look like a hiccup in two years as long as investors do not panic and bale out now.

The bullish conclusion from this view is that the present is a good time to buy into emerging markets, many of which have fallen from their highs and look good value.

Mr Bates conceded, however, that Mexico has not helped the emerging-market sector. "It is unusual these days to find a market that bucks the international trend," he said, and Mexico has triggered a pronounced downward move.

So diversifying risk is crucial to emerging-market investment. Over the last three years an impressive range of unit and investment trusts has developed, with huge differences in focus and geographical range.

The Robert Fleming fund covers emerging markets across the world. "It's a lot less risky that trying to rifle-shoot, when you might hit the wrong target," said Mr Bates, who also holds a wide variety of stocks within a particular market to diversify the risk.

Differing investment strategies have led to vastly different performances between funds recently. Over the past three months, for instance, some Latin American funds have produced no return, while others have delivered up to 30 per cent growth.

While Mexico is clearly a troublespot, many fund managers still believe Brazil and Chile are good bets.

Meanwhile, the more widely diversified funds usually reflect the favourable view of Far Eastern markets. Fleming's fund is fairly typical, with 50 per cent invested in the Pacific Basin, only 18 per cent in Latin America and 12 per cent in Eastern Europe. The balance is placed elsewhere, such as South Africa.

But such investment advisers as Greg Middleton take an even more cautious view when suggesting where individuals should put their cash.

"Any growth fund must have an exposure to the Pacific Basin, where the economies are relatively stable," said Michael Read, head of the private client department. "But investors should avoid Latin America and Eastern Europe, which are too volatile. India is a promising economy but needs to be watched because the political situation is unpredictable." He also advised people to look carefully at the discount or premium on investment trust shares before buying.

When emerging markets were fashionable a few months ago, many funds rose to a substantial premium over asset value.

Even now, the shares of such funds as Templeton Emerging Markets still trade at a 1 per cent premium. To make up for this the fund's return needs to be correspondingly higher, which may be hard to achieve.

Catching a high-performing fund that is trading at a discount, such as Abtrust New Dawn, may prove to be a wiser long-term investment.

So what proportion of a growth portfolio should private investors put into emerging markets? Mr Read advised UK-based investors to risk no more than 7 per cent."We feel they are very high risk for most people." Although this sounds a small proportion, it is more than clients are advised to put into either the United States or Europe.

A 7 per cent exposure will probably not make you a millionaire overnight, but nor will it make you a pauper if things go wrong. And looking at Mexico, who can argue with that?