Low debt lets emerging markets grow faster as they feed larger economies with raw materials

Emerging markets offer growth, and fishmeal

NEW YORK — You can boil down the appeal of emerging markets for investors to three words: growth, debt and fishmeal.

For more than a decade, industrializing countries like Brazil and China have drawn investors seeking to ride their rapid economic growth. Now, money managers are looking to places that feed these emerging giants — like Peru, the world’s top source for fishmeal, a key ingredient in animal feeds.

Since the financial crisis hit two years ago, cash has flooded into the developing world from those seeking better returns and safety. Unlike the U.S. and other developed countries whose governments borrowed heavily for stimulus spending, countries in South America and Asia have smaller debt burdens along with higher bond yields.

So far, investors’ bets in developing countries have paid off. The MSCI emerging market stock index posted a 78 percent gain for 2009 and is up 3.8 percent this year. Funds that invest in emerging-market bonds returned 32 percent last year. This year, JPMorgan’s emerging market bond index has gained 7.4 percent on price terms alone.

Ask Francisco Alzuru, a money manager at Hansberger Global Associates, to explain the popularity of emerging markets and he’ll tell you about fishmeal. It’s essentially anchovy powder. Anchovies are hauled from the Pacific and mashed into a flour, which is then turned into feed for hogs and fish in China.

To Alzuru and investors like him, fishmeal represents increasing trade within the developing world and economic expansion beyond the so-called BRICs - Brazil, Russia, India and China. Those four emerging-market stars still claim the bulk of investors’ funds, but Peru, Turkey and others have seen a surge in cash.

“You see a growth and consumption story in these countries just like you’re seeing in the BRICs,” Alzuru said.

Peru’s economy, for instance, has grown at an annual rate above seven percent, a “China-type speed,” fueled by exports of copper, textiles and fishmeal to Asia. That economic growth has given individual Peruvians higher incomes and more money to spend.

“You see an enormous consumption boom,” Alzuru said. And the rise in spending has helped launch companies catering to Peruvian consumers.

In the 1990s, emerging-market investments were a great way to lose money. The Asian financial crisis, Russia’s debt default and other events crushed many investors.

The stigma from those crises has largely disappeared. Brad Durham, managing director at fund tracker EPFR Global, said it’s remarkable how quickly attitudes have changed, a shift he sees reflected in the numbers. Durham said that in a typical year over the past decade investors might have dropped $15 billion into emerging-market stocks and $9 billion into emerging-market bonds.

Contrast that with the haul for emerging-market funds so far this year: $40 billion into stocks and a record $25.6 billion into bonds. Last year, investors put a record $83.3 billion into emerging-market stock funds.

“The idea that emerging markets are a risky asset has started to unravel,” Durham said. Judging by the flow of cash, investors seem to fear U.S. stocks. EPFR’s data shows they’ve pulled $23.4 billion from U.S. equity funds this year.

Financial turmoil in the United States and Europe has helped make developing countries alluring to investors worried about another Greek debt crisis. Taken together, the world’s advanced countries have debt levels above 90 percent of gross domestic product, according to the International Monetary Fund. The IMF, which counts Treasury bonds held in the Social Security fund, expects the U.S. government to top that mark by the end of this year. The tally for developing countries is 38 percent and shrinking, according to the IMF.

Many economists and investors believe higher debt levels will stunt growth. High-profile fund managers like Bill Gross at the bond giant Pacific Investment Management Company argue that the United States and Europe will be weighed down with sluggish spending and high unemployment for years to come, like Japan has been. That only adds to the appeal of fast-growing countries in Asia and South America.

The IMF forecasts that the United States and other advanced economies will collectively expand 2.5 percent this year and the next. Its forecast for developing countries: 6.3 percent and 6.5 percent.

“This is part of the global marketplace that is actually growing with real economic activity,” said Lupin Rahman, a vice president of portfolio management at Pimco. And it’s not all thanks to China. Pimco expects emerging markets excluding China to post 5.5 percent annual growth this year. She points to a rise in growth and consumer demand from Colombia, Panama and Peru.

Plenty of risks remain.

“Anything that hurts global trade hurts the developing world,” Rahman said.

One danger, she said, is anger in Congress about the value of China’s currency. A tariff on Chinese goods would also pinch Indonesia, for example, because it exports wood and coal to China.

But the developing world has started to wean itself off the American consumer, selling its wares to China as well as to its own growing middle class.

“This is no longer a story for 20 years from now,” Rahman said. “It’s a story that’s happening right now.