Wide horizons where the new dawn breaks

Developing markets offer the prospect of high returns for people prepared to chance their arm

The burgeoning economies of Asia, Latin America, Africa and Eastern Europe offer great growth potential for investors prepared to accept high risk.

Cheap labour, increasing domestic demand for goods and, in many cases, government-backed incentives have enabled a lot of companies to set up and flourish in very short periods. The developing economies of South- east Asia and Latin America have already proved a fruitful picking ground for investment managers. They are now turning to the newer markets of India, China, Africa and Eastern Europe.

Definitions of an emerging market vary considerably. That of the World Bank is based on per capita income of a country, while investment management companies often have their own criteria. But from the point of view of investors, the essence of an emerging market is that the rates of growth in its economy and in the shares quoted on its home stock market are likely to be far in excess of those in mature stock markets such as Western Europe, the US and Japan.

Philip Ehrmann, of NatWest owned Gartmore Fund Managers, says: "In the US economy we are looking for about 2 per cent economic growth over the next couple of years; in Europe from 1.5 to 2.5 per cent; but in Asia, excluding China, we are looking for about 6.8 per cent growth in 1996- 7."

One factor in the creation of emerging markets is the triumph of capitalism over communism. Sarah Ross, of investment manager Foreign & Colonial, says: "Since the fall of communism there has been a gradual move to espousing free markets all over the world."

Favoured markets are those in which governments have introduced big programmes of economic reform - breaking down trade barriers, allowing the free flow of foreign capital into the country, privatising and deregulating industry, and managing inflation and currency. In addition, they need strong and well-regulated stock markets.

Ms Ross says Argentina is a good example. In 1991, the Argentinian government launched a radical reform programme on tariffs, foreign investment and the management of currency and inflation. "Ten years ago the idea of investing in Latin America was very unappealing, but we are now much more positive about those countries committed to reform and economic liberalisation."

However, the very fact that these countries are going through political and economic change also means there is great potential for things to go wrong. For example, Mexico was, until a few years ago, one of the stars of the emerging markets world. But in December 1994 it suffered a stock market crisis, initiated by political assassinations and financial mismanagement. The stock market plummeted by one-third in value and brought down the stock markets of other emerging countries in its wake.

However, there has been considerable recovery since the low point in early 1995.

Mr Ehrmann says: "Markets tend to swing to extremes. People get too pessimistic or too confident and markets overshoot. In 1994 investors were getting carried away with the emerging market message. Valuation levels were at an historic high and people believed they could do no wrong. So when Mexico began to go off the rails, the impact was that much more dramatic than might have been the case."

A key characteristic of many emerging markets is their high risk and volatility, and checking the latest prices every day is not beneficial to a good night's sleep. But for those investors who are prepared to take a higher risk with a small part of their spare cash, an emerging market fund may be the place to look - as long as you are prepared to lock up the money for a good few years and forget about it.

However, Mr Ehrmann says that as the emerging markets are so volatile, it is probably better to go for regular payments into an investment fund rather than trying to guess the best time to invest a one-off sum.

There are three sorts of fund: those that invest in just one country; those that invest in a region; and those that invest throughout the world.

Ken Nicholson, of investment manager Templeton, says the best way for investors to reduce risk is to go for a global fund. "This will provide more diversification than a regional or single country fund," he says.

"The fund manager can pick the best investment bargains from all over the world and is not restricted to one region. As individual markets can be volatile, greater diversification can spread the risk."

Even so, there are still some markets considered too risky. "In Russia there is lots of hope but there is not a strongly regulated legal system that allows company law to protect shareholders," says Mr Ehrmann. "It is still very much frontier territory.

"In the case of Africa, there is also a lack of regulation and there is not the same catalyst for growth. The growth of regional trade is something we look for in emerging markets, but there is no strong trading bloc emerging in Africa so far."