NEW YORK — Not all emerging-market stocks are the same.
A wide menu is available, from copper miners in Latin America to natural-gas giants in Russia to casinos in Cambodia. Unfortunately for investors in emerging-market index mutual funds and exchange-traded funds, some managers say the menu is tilted toward the stocks that are less desirable. That's because the indexes are based on market size, so bigger stocks and bigger markets carry more weight. These are also some of the countries and industries that are feeling the most pressure from a slowdown affecting emerging markets.
The MSCI Emerging Markets index has more stocks from China than any other country, for example, at 18 percent. China's economy is also a top concern for economists, as it tries to shift from growth that's dependent on investment to more consumer spending. The International Monetary Fund expects China's economic growth to slow to 7.7 percent next year from 9.3 percent in 2011.
Worries about weaker growth mean Chinese stocks have lost 7 percent so far this year, including dividends, which looks worse when compared with the 19 percent return for the U.S. market.
That's one reason investors have been turning to actively managed mutual funds this summer. Such funds generally charge higher fees, but those that are run by talented, or lucky, stock pickers have a chance of beating the index.
"Now, you're seeing greater dispersion in returns from countries," says Patricia Oey, a senior analyst at Morningstar. "Some are doing really well, and some are doing very poorly. You could argue that it gives active managers a chance to outperform because if you can avoid those countries, it makes it easier to beat the index."
Consider Thornburg's Developing World fund (THDAX), which has a five-star rating from Morningstar. It has benefited from picks that Portfolio Manager Lewis Kaufman has made in Southeast Asian economies, where he says growth looks to be more resilient.
His recent picks have included VGI Global Media, an advertising company in Thailand, and NagaCorp, which operates the largest hotel and casino complex in Cambodia. Both those stocks have returned more than 30 percent in 2013 in dollar terms, and they're part of a rising tide for stocks in several Southeast Asian countries. Stocks from the Philippines have returned 15 percent, and Thai stocks are up 3 percent.
Kaufman's fund is up 7 percent this year, putting it in the top 4 percent of all diversified emerging-market stock funds. That compares with a 7 percent loss for the MSCI Emerging Markets index.
Kaufman says he hasn't written off stocks from Brazil, Russia, India and China, the first emerging markets that come to mind for many investors and collectively known as the BRICs. But he's being choosy.
"There's some temptation to say that BRICs are bad and non-BRICs are good," he says. But within BRICs, he's focusing on companies that stand to benefit from expected gains in consumer spending.
Not only does a wide gap exist among emerging markets between winning and losing countries, but also between industries. Consumer-related companies have held up better, for example, as investors bet that the middle class in developing economies will continue to expand. Stocks of companies that sell household products and other staples have been able to hold up, returning a fraction of 1 percent, for example.
"Anything more consumer-related has done well," says Doug Ramsey, co-portfolio manager of the Leuthold Global fund (GLBLX), which has a four-star rating from Morningstar. The problem is that their availability is more limited, he says.
Sellers of consumer staples make up just 9 percent of the MSCI Emerging Markets index, for example. The index instead is more dependent on financial companies, the biggest industry in the index at 27 percent. Financial stocks have lost 6 percent this year.
Other big industries in the index have seen even steeper declines: Producers of raw materials have lost 21 percent, and energy companies have lost 11 percent. Those two industries make up 21 percent of the index together.
— INVESTORS HAVE NOTICED
Indexes that track emerging-market stocks have been falling steadily through the year, but the losses accelerated in June. The MSCI Emerging Markets index lost 6 percent that month, though it has recouped a portion of its losses in July. The slide pushed many investors to flee emerging-market ETFs. The majority of these track emerging-market indexes, and investors yanked $6 billion out of them last month, according to Morningstar.
But investors also put $2.1 billion into traditional emerging-market stock mutual funds, according to Morningstar. The majority of these are actively managed.
— HOW MUCH MORE CAN ACTIVELY MANAGED FUNDS COST?
The Thornburg fund run by Kaufman has an expense ratio of 1.69 percent, according to Morningstar. That means $16.90 of every $1,000 invested in the fund goes to cover operating costs. Compare that with Vanguard's Emerging Markets Stock Index fund (VEIEX), where expenses eat up $3.30 of every $1,000 invested.