Cheap buys in emerging-market ETFs

From being everyone's favourite asset class after the financial crisis, emerging-market shares are now bottom of global investors' shopping lists.

China's economic slowdown is in the news almost every day; the shares of Russian gas giant Gazprom languish at a third of their 2008 peak; India's credit rating is under pressure; and Brazil faces growing upheaval. The gloom surrounding these Bric' nations is also reflected in the average portfolio.

Bank of America Merrill Lynch's widely followed investor sentiment survey shows that fund managers currently own a smaller share of emerging-market equities, relative to their benchmarks, than at any time since 2001. French bank Socit Gnrale recently reported that 51% of global investors were bearish on the global emerging-market equity sector, the largest negative score ever recorded.

Those sorts of figures have contrarian investors licking their lips. GMO, the US-based money manager famous for calling the top of the internet bubble in 2000 and the equity-market peak of 2008, recently said it prefers emerging-market stocks to most other asset classes. While it's still quite negative on China, the firm expects an average annual real (post-inflation) return of around 6% for the next seven years from a basket of emerging-market equities.

By contrast, it expects negative real returns over the same period from US large and small-cap stocks, and from US, international and inflation-linked bonds.

Underlying GMO's views is an assumption that asset prices eventually revert to the mean assets that are expensive today will get cheaper in the long run, and those that are cheap will become more expensive. So you want to buy assets when they're cheap.

There's a wide range of emerging-market equity exchange-traded funds (ETFs) available to UK-based investors, including funds tracking one or a number of countries, entire regions, or indices with a certain investing style.

Be aware that in emerging-market investing, you often find extra replication costs built into funds' returns (in other words, they underperform the index benchmark by more than the stated fund fee).

Always check an index-tracking fund's return against its index and look out for any unusual divergence.

One ETF tracking a broad, multi-country index that's so far done a good job keeping replication costs down is Vanguard's FTSE Emerging Markets ETF (LSE: VFEM).

Paul Amery is a freelance financial journalist, formerly a fund manager and trader.