The best emerging markets to buy now

Investors in emerging markets haven't had a great three years.

Since January 2011, the MSCI emerging markets index is down 12%, while developed markets such as the US and Japan have soared.

And with investors jittery over the Federal Reserve cutting back on money printing, emerging markets could be in for more turbulence.

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But that doesn't mean you should ignore emerging markets. There's plenty of opportunity out there you just have to be picky.

Pick countries that are reforming their economies

But this cheap currency strategy isn't really working anymore. Developed markets in Europe and the US aren't buying as many imports as before. And with shale gas driving down energy prices in America, we're even seeing some manufacturing return to the US.

So emerging market countries now need to focus on boosting consumption at home, and creating economies that can deliver sustainable growth.

And you're much more likely to achieve that goal if you can combine good corporate governance with a free(ish) market economy.

China is one country following this path. Last month's Third Plenum' announced a new reform programme to be implemented over the next decade. I've already covered the plenum here, but I can say that I've become even more positive since I wrote that piece.

It looks like the new Central Reform Group' will be a big driver of reform, and if President Xi Jinping ends up running the group, that will be further confirmation that this reform programme is for real.

One of the most interesting aspects of the reform package is its focus on state-owned enterprises. These companies control large parts of the Chinese economy, and aren't exactly dynamic.

They're now going to be expected to pay higher dividends, which in turn should put them under greater pressure to behave like true profit-maximising businesses. In other words, they'll have to care about things like efficiency, waste, and maybe even customer service.

This is all very encouraging.

Even better, valuations in China still look cheap. The Shanghai Composite Index is trading on a price/earnings (p/e) ratio of just 11, and the market is 50% below its 2007 peak.

I've previously highlighted the JP Morgan Chinese investment trust and I still like it. It invests across Hong Kong, China and Taiwan and has a good record of beating its benchmark. The discount is 10% (in other words, you can buy the trust for less than the underlying value of its portfolio). This is fairly average, so there's no great scope for a large narrowing of the discount, but there is plenty of potential for strong growth in the fund's net asset value.

I also like the First State China Growth fund. Once again, this fund invests across Hong Kong, Taiwan and China. It's the top-performing China fund in recent times and places a big emphasis on governance as part of the investment process.

It's not just about China

The most significant part of that package is now progressing through the Mexican parliament. That's the abolition of the monopoly held by state-owned oil company, Pemex.

All of Mexico's oil reserves are owned by Pemex. But Pemex doesn't have the expertise to extract shale gas and oil from Mexico's less accessible oil fields, and the large Western oil companies aren't willing to help unless they can own a chunk of the reserves. ExxonMobil isn't interested if it's just paid a service fee.

The reforms mean that large Western oil companies can own a stake in the reserves. So you should expect to see higher oil production in Mexico, as well as cheaper energy for the Mexican economy.

Sadly, the Mexican market isn't as cheap as China. The flagship index, the IPC, is on a p/e of 20, with a dividend yield of 1.49%. Still, the potential is big, so I'm tempted to invest here - but on a smaller scale to China. My colleague James McKeigue runs through some ways to invest in Mexico here.

The countries that aren't reforming

India is interesting at the moment. It's possible that it will move firmly into the reform' camp in 2014. If Narendra Modi, currently chief minister of Gujarat and a keen reformer, wins the next Indian election in six months' time, he could combine with the new governor of the central bank, Raghuram Rajan, to push through changes.

You can't be certain how the election will go, so I'm not suggesting you should invest in India right now (it's not cheap either). But keep it on the watch list.

Russia and Brazil on the other hand, are floundering badly. Their political leaders don't appear to have the stomach for serious change.

Don't get me wrong, if you invested in either country now, you might make money. Neither is expensive, and Russia, in particular, looks cheap on several measures. If you are looking for a high-risk bet that could potentially pay off, it's worth a look, as my colleague Merryn Somerset Webb has mentioned on several occasions.

However, for my money, China and Mexico while still risky are at least progressing in the right direction. If they can keep that up, it should make them better bets than countries that are in danger of being stuck in the emerging' camp for good.

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