The most important thing is for the shareholder to understand what the fund manager is doing, whether there are limits or not. Getting the information out is up to the fund-management company, but understanding it is up to the investor–it’s a two-way street. If you send loads of material home but the investor never reads it, the fund company has done all it can. The investor has to take the time to read the prospectus, to understand the flexibility of the fund, to ask questions. If you’ve done that, investors who don’t like flexible funds will choose one with more rigid guidelines. Compared with what investors did before–investing through brokers in very undiversified methods–buying a diversified mutual fund is a big improvement. But if all they do is pick a fund and don’t read the prospectus, they have no one to blame but themselves. Peter Lynch used to say that people spend more time identifying what toaster to buy than what investments to buy. This is people’s hard-earned savings–they should spend time understanding what they’re doing.
There is risk, but with risk comes reward. It has to do with one basic fact: while the U.S., Japanese and European economies will grow at 2 to 3 percent a year in the next decade, the emerging-market economies are likely to grow at 6 to 8 percent. That economic growth is like the wind at the back of an emerging-markets investor. As these economies grow, their companies get stronger, their profits increase and so do the returns to investors.
The risk comes because these economies tend to be more fragile, and as a result, there’s more market volatility. Whereas the U.S. market tends to drop 20 percent in a really good correction, some of these emerging markets can drop 30 to 50 percent. But if I had to bet which asset class–emerging markets or the S&P–will do better over the next decade, there’d be no question what I would bet on.
The best opportunity in the world right now is also the most volatile: the Russian stock market. This is an economy in its third or fourth year of reforms, in which people do not believe that the reforms are sustainable. Russian companies are essentially selling for pennies on the dollar. There is likely to be a massive revaluation as this economy stabilizes. But it’s not for the fainthearted. You have companies there like Mosenergo, an electric utility serving Moscow, selling at an 85 percent discount to U.S. utility-company valuations. You have companies like Lukoil, Russia’s largest oil company. It has the same oil reserves as Mobil, but sells for less than one sixth the price. You could buy these stocks through ADRs, securities of foreign companies that trade on the U.S. exchange, but only if it’s money you can afford to lose, like playing the lottery. For general investments, choose a diversified emerging-markets fund.
The average investor is woefully underinvested in emerging markets. We’re talking about regions that contain 15 percent of the world’s stock-market value. If the average individual has 1 percent invested there, he’d be lucky. If you have a 20- or 30-year time horizon, you could put 15 to 20 percent of your portfolio in emerging markets. People spend a lot of time investing in small companies in the U.S. when their bottom line is just as volatile, if not more volatile, than the strongest companies in an emerging market. And in some sense investing in emerging markets is easier: you have history to guide you. For instance, telecommunications systems have already been built in many countries, so when you try to forecast how telecom companies will grow in Brazil or the Philippines, you’ve already seen it happen in other countries. The same is true for consumer products: what sells in one country will probably sell in emerging markets. It’s a lot harder investing in technology stocks in the United States, because it’s difficult to predict which new technologies will be successful.
