Should YOU steer clear of emerging markets or is it time to buy?

Making money in emerging markets is not easy. Even veteran investor Terry Smith, hailed as Britain’s Warren Buffett, has announced he will be closing his fund operating in the region, saying it has “underperformed expectations.”

Smith’s Fundsmith Emerging Equities Trust is the third emerging markets fund to close in a few months, after Jupiter Emerging & Frontier Income and ScotGems.

But these fund disappointments don’t mean emerging markets are lacking in investment opportunities. Many experts believe they have the potential to outperform developed markets in the coming years.

However, investors may have to accept a lot of gut-wrenching volatility along the way – and be willing to work to find the best opportunities.

So what exactly are emerging markets?

That is the name given to high-growth economies that have not yet reached their full potential. Like many labels on our investments, the term is one of convenience that hides a huge spectrum of markets.

There are no fewer than 24 countries in the main emerging markets index – as diverse as South Korea, China, Brazil, Mexico, Thailand, Vietnam, India and South Africa.

Should investors follow Smith out the door?

Investing in emerging markets is generally seen as riskier than in so-called developed markets. In many cases, accounting and governance may be less reliable. Therefore, while there is often opportunity for rapid growth, there is a lot of volatility along the way.

Emerging markets have had a very difficult year, with stock markets depreciating a total of 25 percent in the past year. By comparison, the S&P 500 index (a barometer of the health of major US companies) fell 11 percent.

Funds containing Russian investments have been hit particularly hard after global sanctions rendered them virtually worthless. These include Fidelity Emerging and Baring Emerging Europe, which has refocused on Europe, the Middle East and Africa.

A ripple effect of the war has affected other markets by inflating the cost of energy and food. “It has driven Sri Lanka to the point of bankruptcy,” said James Carthew, investment trust expert at data group QuotedData.

China is the largest component of many emerging market funds and is rich in investment opportunities. British investors, however, are massively avoiding the Chinese stock market, amid the appalling treatment of the Uyghurs in the northwestern region of Xinjiang, along with the intimidation of nearby neighbor Taiwan and refusal to denounce Vladimir Putin’s war on Ukraine.

What about the odds?

Investing in emerging markets requires a strong stomach and a long time horizon. Younger investors who have decades to weather the ups and downs can reap the benefits. Others who are likely to need their money within a few years may find it too risky.

Jason Hollands, director of asset manager Evelyn Partners, is optimistic about emerging market funds. “I’m convinced that emerging markets will outperform developed markets equities over the next year and a half,” he says.

Hollands adds that the problems with Smith’s emerging markets fund were related to the way it was structured, not a systemic problem with emerging markets investing.

Dzmitry Lipski, head of fund research at investment platform Interactive Investor, agrees that Smith’s exodus doesn’t necessarily mean that emerging markets no longer offer opportunities. “We wouldn’t see this as a broader ‘sell sign’,” he says.

Would they be about to turn a corner?

Emerging markets are ripe for recovery, said Carlos Hardenberg, founding partner of Mobius Capital Partners and manager of Mobius Investment Trust.

“They’ve been through one of the longest and most difficult economic recessions in decades,” he says. “It makes them look stronger than ever before. This is not the time to sell. It’s time to buy.’ There are plenty of reasons to be excited about many of these markets. Many have a growing middle class with more money to spend and a hunger for consumerism.

Emerging markets also generate more than half of global economic growth, despite recent challenges. Chetan Sehgal, who leads the Templeton Emerging Markets Investment Trust, is particularly enthusiastic about the technological innovation in the sector.

“Emerging markets are home to companies that are familiar with new technologies that will drive future sustainable economic growth,” he says. “From manufacturers of solar and electric car batteries to semiconductor designers and manufacturers, the acceleration of innovation drives our confidence.”

A vast area… so fate varies

Emerging markets cover a vast global area, with many diverse economies. As a result, emerging market funds vary wildly.

Matthias Siller, co-manager of Barings Emerging EMEA Opportunities, is excited about South Africa for its access to a wide range of metals. Charles Jillings, who runs the Utilico Emerging Markets Trust, has 22 percent of his fund in Brazil, which looks cheaper than it has in a few months. Others rave about India, a favorite of Darius McDermott, director of wealth platform Chelsea Financial Services. “The demographics are great and the politics are business friendly,” he says.

Don’t get in … but invest in drip feeding

Even if you’re confident of emerging market potential, it’s a good idea to keep your investments small and diverse.

McDermott recommends investing slowly. “I wouldn’t bring in a lot of money right now, but a little IV feeding can pay off in the long run,” he says.

Lipski suggests that these markets should not make up more than 10 percent of your portfolio because of their volatility.

Carefully study the funds you choose

Emerging market funds vary greatly, so it’s important to check what you’re buying.

John Moore, senior investment manager at asset manager Brewer Dolphin, introduces JP Morgan Emerging Markets. It invests in several markets, with India leading the way, followed by China, Taiwan and South Korea. It is up 5.6 percent in three years and down 22 percent in one year.

He also likes BlackRock Frontiers Investment Trust, which invests outside of traditional emerging markets. It is up 14 percent in three years and 0.4 percent in one year.

“The biggest exposure is to Saudi Arabia, then Indonesia, Thailand, Kazakhstan and the UAE,” he says.

For those wanting something a little more traditional, McDermott recommends FSSA Global Emerging Markets Focus, which he says invests “in 40 to 45 quality large and mid-sized companies that can demonstrate sustainable and predictable growth.”

It is up 0.4 percent in one year and 10 percent in three years.

Meanwhile, Hollands, Lipski and Moore all mention the Utilico Emerging Markets Trust.

Moore says the fund focuses on infrastructure, making it less prone to violent fluctuations in value. This is because governments tend to invest in infrastructure at all stages of an economic cycle, so it can perform well even in difficult times.

The fund is down 0.5 percent this year, but is up 0.6 percent over three years.