Special Report on Investment trusts: Emerging markets come up trumps: While the rewards can be extremely high, the risks are also significant, writes Heather Connon

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BRITAIN'S stock markets may have soared to new heights in 1993, but the real money was to be made elsewhere. The 20 per cent rise in shares in Britain's leading firms pales into insignificance compared with Poland, where shares rose almost 800 per cent, or Jakarta and Manila - both up more than 200 per cent.

For many small shareholders, nervousness about investment in such exotic locations is entirely sensible. There are no guarantees when investing in shares, even in long-established and regulated stock markets such as those in Britain, and there is always a chance that you will lose a large part, or even all, of your investment.

But it applies even more strongly in emerging markets - the Far East, Latin America or eastern Europe. There, stock markets are often new, or only recently opened to investors and poorly regulated; the economies are volatile and the countries often politically unstable; and companies may be recently formed or dominated by family shareholdings. While the rewards - as the 1993 performances show - can be high, the risks are also significant.

Such concerns have not stopped investors piling in. Many large institutions such as pension funds and insurance companies have direct shareholdings in companies from less-developed countries. There is also a large number of investment trusts specialising in these areas which have been launched in recent years.

And these trusts have done well in emerging markets. Last year, Far East trusts - both including and excluding Japan - were in the top four performing sectors of the investment trust league tables, rising by at least 80 per cent over the year. They were only beaten into the top slot by property trusts, which had been in the doldrums for years.

The dramatic outperformance and investors' enthusiasm for these new investment areas has, however, meant that many trade at premiums to their net asset values - in sharp contrast to other investment trusts. The average premium on emerging market trusts is 3 per cent, which means that shareholders are asked to pay pounds 103 for pounds 100 worth of assets. If growth continues that may prove a bargain but if the markets reverse it will look like an expensive mistake.

Such dramatic outperformance often brings a further flood of money as investors scramble to share in the rewards. But there must be a question mark over how much further shares in emerging markets can rise given their staggering performance last year.

Before deciding to switch all your money into emerging markets, it is worth remembering that sectors which have performed well in one year are often laggards the following year. In 1989, for example, financials topped the league with 90 per cent growth. The following year, however, they were bottom of the table, having halved in value.

That does not mean emerging markets should be ignored, but it does mean they should be treated with caution. Private investors should already have a balanced portfolio of British trusts, or shares in individual companies, before they think about less-developed areas. Lewis Aaron, who researches investment trusts at Warburg Securities, points out that emerging market trusts account for less than pounds 1bn of the pounds 80bn investment trust sector.

'If emerging markets are less than 1 per cent of the world's market capitalisiation, I would not recommend private investors to have more than 10 per cent in the area.' And those such as pensioners, who rely on regular income and want to preserve their capital, would be better off in a general British trust.

Investors who do decide to risk some of their money in the sector then have to chose whether to go for a general emerging markets trust, where the fund manager will chose which country to put money into, or to chose a specific country. Hugh Young, one of the managers of Abtrust Emerging Markets, launched last November, says: 'If you have a large enough portfolio - say more than pounds 100,000 - you can buy a China fund, a Thailand fund, a Philippine fund and a Mexican fund and get yourself a nice, balanced portfolio. But if you only have a China fund, you could be either very right or very wrong.'

He believes emerging markets will continue to perform well pointing out that, even after last year's rise, shares are on about 20 times the earnings expected this year. While that is rather higher than the 16 or so times in Britain, growth is likely to average 20 per cent, twice that expected here. 'It is not cheap, but it is not all that expensive.'

Fleming's Mr Bates adds: 'A lot of the markets are in need of correction, and some of them are having one. But the long-term story is still attractive, based on sustained levels of growth.' And he points out that many British companies - such as Unilever, Shell and ICI - are already investing heavily in these markets so even those who chose an exclusively British portfolio are getting some exposure to the area.

Many emerging markets are still closed to foreign investors, or entry is restricted to those who have made special arrangements with the authorities. More are, however, opening up - Papua New Guinea recently announced it was opening to overseas investors.

Buying an investment trust will let private investors into these areas - and it should also mean that the managers will have done their homework on the companies before they buy. Mr Young said that his managers visit every company before they buy its shares - it has seen 300 in Singapore, for example, although it has only invested in 95 of them.

'There is a danger that you will walk along looking up at the blue sky thinking everything is wonderful and then fall down a manhole,' says Mr Young. 'We make sure we keep our eyes firmly on the ground.'

(Photograph omitted)