No need to panic over emerging-markets downtrend

After years of strong performance, emerging-markets stocks are trending down, but some industry experts said now is not the time to bail.

Instead, investors should be looking to add emerging-markets exposure.

“Emerging markets have pulled back,” said James Paulsen, Minneapolis-based chief investment strategist with Wells Capital Management Inc. of San Francisco. “That gives you sort of an entry point.”

That’s advice that may be hard for some investors to stomach.

Year-to-date through Aug. 18, the MSCI Emerging Markets Index had fallen 22.92%, while the Standard & Poor’s 500 stock index had dropped just 11.75%.

It doesn’t seem likely, however, that emerging markets will underperform for long.

The proportion of total market capitalization represented by the emerging world has increased by almost 1% per year since 1999 and stands at about 13%, according to a report last week from Baring Asset Management Inc. of Boston.

That percentage, however, is expected to increase dramatically over the next 10 years, the report said.

Emerging-economy market capitalizations — plus Hong Kong and Singapore — will account for up to a third of global markets by 2018, according to the report.

That means investors should expect continued solid performance from emerging markets.

“There is still a strong long-term-growth story in emerging-market equities,” James Syme, head of the global emerging-equity team at Baring, said in a statement. “Recent moves to floating exchange rates, the independence of central banks, current account surpluses, declining interest rates and reduced levels of debt have all made emerging markets an increasingly attractive investment proposition for investors prepared to take a medium- to longer-term view.”

That analysis makes sense, Mr. Paulsen said.

To take full advantage of the anticipated growth in market cap, investors may want to begin allocating more to emerging markets than what benchmarks suggest, he said.

“Ask yourself: ‘Where will everyone be in 10 years?’” Mr. Paulsen said.

If emerging markets are going to account for a larger portion of global markets, “why not go there now?” he said.

It’s a logical conclusion, said Richard Schroeder, executive vice president of Schroeder Braxton & Vogt Inc., an Amherst, N.Y., financial advisory firm with $220 million in assets.

Emerging markets will likely continue to grow and account for a larger slice of the global markets and, as a result, outperform, he said.

But emerging markets are volatile, Mr. Schroeder said. “You have to balance your desire to be globally diversified with the ability to sleep at night,” he said.

The current environment is a perfect example. “Emerging markets are being affected by quick drops in commodities prices,” Mr. Schroeder said about the recent drop in emerging-markets returns.

Many clients wouldn’t take kindly to being too concentrated in emerging markets during such periods of volatility, he said.

Mr. Schroeder gave that, and a natural bias clients have toward being invested in domestic markets, as two reasons why he probably will never have an allocation that mirrors the global weightings cited by Baring.

“I don’t have 13% of a portfolio in emerging markets,” Mr. Schroeder said. “The most aggressive portfolios I run have less than half that.”

Depending on the investor, that may be just fine, said Peng Chen, president and chief investment officer of financial research firm Ibbotson Associates Inc. of Chicago.

“There is going to be a lot of volatility in emerging markets,” he said. “The peaks and the valleys are much wider.”

Mr. Chen said, however, that over the long term, he expects emerging markets to continue to grow as a percentage of the worldwide market. That should help emerging-markets stocks outperform, he said.

E-mail David Hoffman at [email protected].