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In search of growing markets

DAVE EBNER begins this series with an in-depth look at the emerging markets of Russia, India and South Africa


Emerging markets are not for the timid, prone as they are to wild swings higher and harrowing plunges lower. But high risk often equals high returns, and aggressive investors can bolster their portfolios by moving money to areas of the world that promise rapid growth.

"These markets offer exposure to cyclical, value stocks," said David Rosenberg, chief strategist and economist at Merrill Lynch Canada Inc. "Emerging markets tend to be export-oriented windows on the world economy, trading at a discount to the U.S. market."

Emerging markets are a diverse bunch, ranging from Brazil, to China, to South Africa and Russia. According to Morgan Stanley Capital International, South Korea and Taiwan together account for a third of the spectrum. Despite numerous risks, some observers say most investors should allocate about 5 per cent of their portfolios to emerging markets.

"Quite frankly, emerging markets should be a part of everyone's portfolio," said Gavin Graham, investment director at Toronto-based Guardian Group of Funds.

For purposes of this article, we'll focus on the so-called "emerging emerging" markets: South Africa, Russia and India. These are three large, influential countries, together amounting to a fifth of the emerging markets total. But they are the riskiest of the lot. (Other parts of Asia, Latin America and Europe will be dealt with in subsequent parts of this series, in coming weeks.)

Because the growth of such markets is fairly dependent on the global economy, Mr. Rosenberg says, investors who think the world is stumbling toward troubles should avoid them. Currency risk is another factor, seen in returns from foreign stock markets. For instance, the South African benchmark FTSE/JSE Africa All Share index has climbed about 10 per cent annually in rands over the past three years but in Canadian dollars it's down about 5 per cent annually. The flip side is that, if recent economic struggles merely represent a pause in a broader trend of growth, investments in India, Russia and South Africa could quickly prove wise and profitable.

There isn't a particularly large selection of products with direct exposure to Russia, South Africa and India available for Canadian investors.

A number foreign companies that list American depositary receipts in New York, such as Moscow-based energy giant Yukos and software services company Infosys Technologies Ltd. of Bangalore, India.

On the mutual fund front, products that offer notable exposure to Russia, India and South Africa are also limited. But analyst James Gauthier of Toronto-based Dundee Securities Corp. identified several with significant money in those markets.

The HSBC Emerging Markets Fund -- down 10 per cent this year -- and the GGOF Centurion Emerging Markets Mutual Fund -- down 9 per cent in 2002 -- both have about quarter of their assets in the three countries, weighted more toward South Africa than India and Russia.

RBC Advisor Emerging Markets Equity Class Fund -- down 4 per cent year-to-date -- has the most money in India, about 12 per cent, while the CIBC Emerging Economies Fund -- down 12 per cent this year -- has the most in Russia with about 8 per cent.

South Africa -- a resource-rich country with half the world's gold reserves -- is a focus of some precious-metals funds and amounts to a third of the assets of the Mackenzie Universal World Precious Metals Capital Class Fund, which is up 30 per cent this year.

A brief survey of this week's featured countries follows:
South Africa

Merrill Lynch & Co. Inc. said last week that it estimated South Africa's long-term growth rate at about 3 per cent annually, similar to projections for Canada and the United States.

Racial tensions remain strong in the country, just a decade beyond the racist apartheid regime. A recent government proposal mulled transferring control of the country's robust mining sector to the majority black population.

South Africa also faces a huge health crisis as an estimated tenth of its population is HIV positive.

Still, Merrill said the country has many strengths, including its vast base of resources, strong tourism industry and a fiscally disciplined government.

"South Africa has a lot going for it, but there are clearly some structural issues that are going to take a long time to resolve," wrote Ed Butchart, Merrill chief global emerging markets strategist, in a report to clients.

Some observers say too much emphasis has been cast on the country's negatives.

"If you look below the surface, things are not as bad as they seem," said Mark Mobius, a long-time emerging markets investor at Templeton Investment Management (Hong Kong) Ltd.

Mr. Mobius manages the Templeton Emerging Markets Fund, Canada's largest by assets in the category. The fund is down 4 per cent this year and has about a sixth of its money in South Africa. Its top holding is SABMiller PLC, a brewer formerly known as South African Breweries PLC.

"You're basically getting First-World companies at Third-World prices," Mr. Mobius said. (One Canadian dollar is equal to about seven rand.)

Just behind China, India is the world's second-most populous country with more than one billion people. The country's real domestic product growth averaged 6 per cent annually through the 1990s and it has a growing number of skilled professionals, especially in the technology sphere.

But the benchmark Sensex 30 index, following big names on the Mumbai Stock Exchange, has struggled since the tech sector bubble exploded in 2000. While the Sensex doubled its value through the last thrust of the tech boom in 1999, it has since lost those gains and more, now trading at a level first reached in 1992.

Hindustan Lever Ltd., a consumer products giant, is one of India's corporate heavyweights. Several analysts in recent weeks have recommended the stock, including Salomon Smith Barney Inc., saying "current weakness" makes Hindustan attractive. (One Canadian dollar is equal to about 31 rupees.)

The world's largest country by land mass boasts one of the planet's hottest stock markets. The Russian Trading System (RTS) index -- a benchmark of 65 companies measured in U.S. dollars -- tripled from the start of 2001 through this past May. Even though the RTS is off by a fifth from its recent high, it remains up by more than two-thirds in the past year.

The stock boom has occurred as economic growth slows. In early 2000, the Russian economy was growing more than 10 per cent on an annualized basis, a pace that's slowed steadily to the recent pace of about 4 per cent.

Like all emerging markets, Russia is a mix of promise and problems. It is oil-and-gas rich, but is also heavily reliant on the sector. The country also made progress on economic reforms last year, yet more is to be done, observers say.

"The government still needs to implement a massive reform agenda to change the structure of the economy and put the country on a sustainable growth path," said TD Securities Ltd. of London in a new report. (One Canadian dollar is equal to about 20 rubles.)
Do the potential rewards justify the risks?
'Emerging markets tend to be export-oriented windows on the world economy, trading at a discount to the U.S. market.'
South Africa
- Minerals accounted for a third of exports in 2000.
- Long-term economic growth estimated at 3 per cent.
- One-tenth of population is infected with HIV.
- Stocks down 10 per cent this year though up 10 per cent in the past year.
- Population of one-billion accounts for a sixth of the world's total.
- Posted average real gross domestic product growth of 6 per cent annually in 1990s.
- Suffering from a serious drought; one-third of districts have been declared drought zones.
- Stocks down about 7 per cent this year and 9 per cent over the past year.
- Oil and gas account for a third of gross domestic product and half of exports.
- Inflation is falling, down to 9 per cent in first half of 2002 compared with 12.7 per cent last year.
- Reformed tax and legal system last year; more changes are needed.
- Stocks up about a third this year and more than two-thirds in past 52 weeks.

© 2007 The Globe and Mail. All rights reserved.

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