(FORTUNE Magazine) – The high is always sweeter after the low. It's as true for investing as it is for life. So those battered veteran investors in emerging markets are no doubt savoring the phenomenal performance they've seen this year. Indeed, the sound of joyous laughter might even drown out the whimpering you still hear from those nursing the wounds they received in the Asian financial crisis of 1997-98.

There's no doubt--the returns this year have been staggering. The average emerging country's stock index has vaulted 39%. Every single index in the emerging world tracked by MSCI has risen in 2003. Venezuela is up 84%. Russia, Brazil, and Thailand have each generated returns of 50% or more. U.S. investors have poured money into the category at a rate not seen since the mid-1990s.

What's the only thing more surprising than the size of the returns this year? How about this: Despite the rally, emerging-market stocks remain incredibly cheap compared with those in the U.S. The average stock in Latin America, for example, is selling for just nine times projected 2004 earnings. Asian stocks are priced at ten times earnings. The ratio for U.S. stocks is 20.

The bottom line: It's not too late to get in. As we've argued (see box at left), emerging markets represent one of the best opportunities to capture strong returns over the next decade. Certainly, as in the past, these investments are not for those still traumatized by the fall of their Internet stocks. (Look up "risk" or "volatility" in a dictionary, and you could easily find emerging-markets stocks cited in the definition.)

But circumstances have changed. Financial conditions are more stable than in the past. Fledgling economies have been buoyed by rising commodity prices--not just oil, but copper, gold, and other natural resources. And it ain't just natural resources. Asian economies have been growing 5% to 6% on average, and regional powerhouses like India and China are using increased industrial and technological production to expand at rates of 6% to 10%--more than twice the long-term pace of the U.S. economy.

Equally important, many companies now operate quite differently from how they did before the 1998 crisis. Governments, under rules imposed by the International Monetary Fund, are requiring that more information--and more accurate information--is shared with investors. "There's been a remarkable improvement of balance sheets in the emerging markets," says Mohamed El-Erian, a Pimco fund manager who controls $11 billion in emerging-market bonds. "Managements are doing less speculation on things like golf courses and real estate. They're doing smarter business."

Even in this market, of course, none of that guarantees good returns. So we decided to zero in on emerging-markets mutual funds--whose broad holdings minimize the risks inherent in a single stock--and determine which are best positioned for today's environment. To that end, we enlisted analysts at Morningstar and Lipper to help whittle the list of nearly 100 emerging-markets funds to a manageable number by examining performance figures, management philosophies, fees, and risk. After eliminating all but the top-performing quartile--the best performers over the last five years--we ran the names past financial planners, analysts, and market strategists to determine which funds tap into the most fecund markets. The result: four outstanding funds with different philosophies and risk profiles, and nary a cowboy among the fund managers. They are funds that work to smooth out the intense ups and downs endemic to this type of investing.

Indeed, consistency in an inconsistent world provides an apt summary of Matthews Asian Growth & Income. The fund, which focuses on low-priced companies that pay dividends, has largely avoided decline. It has posted gains in each of the past six years and has an average annualized return of 17% during the period. In 1997, its worst year ever, it lost 23% but still ranked in the top fifth of all funds. In 1998, while most Asian funds imploded, it earned 1.2%.

The key to the success of Matthews is a focus on deep value. For example, the fund earned a 30% return this year on shares of Fraser & Neave, a Singapore conglomerate with interests in breweries, publishing, and property, which Matthews had purchased at their lows. The portfolio includes a fair amount of real estate--related companies because they were so decimated in the late 1990s, but Matthews also owns battered tech and energy companies. (It picked up a zippy 67% return this year on PetroChina, the dominant oil-exploration company in that country.) The fund minimizes volatility by buying convertible bonds and preferred stock that offer some downside protection.

Pimco Emerging Markets. Not only has this bond fund beaten other emerging stock and bond funds but its annualized gains of 26% rank it as one of the top-performing mutual funds of any kind for the past five years. The fund has not seen a down year since El-Erian took the helm in 1999 (it did lose 12% in 1998) despite the multitude of country crises that have crossed its path. That consistency helps the fund justify its hefty 4.5% up-front load.

Manager El-Erian is the consummate contrarian. Two years ago, when Wall Street was confident that Argentina would not default on its bonds, El-Erian sold his entire position--well ahead of the country's financial meltdown. Last year, when the consensus was that Brazil would default, he stepped in to buy a chunk of government bonds and made a quick 74% return. More recently he's moved money away from Venezuela--where many other bond investors are betting that resurgent oil prices will bolster the economy--on the view that petroleum alone cannot support the troubled country. Instead, the fund has expanded its stake in Mexico, Peru, South Africa, and Russia, where credit is sound and fundamentals are improving.

El-Erian is no swashbuckler. A former senior official at the IMF, he divides emerging markets into two buckets: those like Mexico that are solid enough to anchor a portfolio, and those like Ukraine that are akin to junk bonds. He keeps most of his money in investment-grade bonds, but uses a sizable chunk to venture into riskier areas.

T. Rowe Price Emerging Markets, which has jumped 29% this year--and 15% a year on average over the past five years (it lost 29% of its value during the Asian crisis)--is a more conservative way to play the sector. Fund manager Chris Alderson is a value investor who currently keeps about 16% of his portfolio in Latin America and 60% in Asia. One of his best moves was scooping up unwanted shares of Taiwan Semiconductor, which have generated a 72% return this year.

Alderson seeks stocks that are trading at a discount of 30% or more to their counterparts in developed markets. Consider Brazil's Petrobras, one of his major holdings. It's selling for a 60% discount to the cash flow multiple fetched by Exxon Mobil despite producing comparable growth. Recently Alderson has been moving money back into China, where he says the SARS scare created buying opportunities. And he has increased his investment in India to 8.5% of his portfolio because he thinks that the country has the most entrepreneurial, well-managed businesses among the emerging markets.

Perhaps the most surprising pick in such a volatile a sector is Vanguard Emerging Markets Stock Index fund. It has bested the average actively managed fund this year with a 35% gain. The fund tracks the Morgan Stanley emerging-markets index, which includes the more liquid markets that are easily accessed by foreign investors. Its 13% average annualized return over the past five years puts it among the top 25% of all emerging-market funds. But when you pick a bumpy investing universe you get a bumpy ride: The fund has lost money in six of the past ten years--in line with the index. Still, it's a good choice for investors with a long-term focus who are willing to ride out the occasional storms. And the no-load, low-fee structure is nothing to sneeze at among emerging-markets funds, which often carry exorbitant loads and fees.

RESEARCH ASSOCIATE Dana Vazquez