(MONEY Magazine) – THIS MONTH: --Zweig on the hidden dangers of index funds --A low-risk fund with global reach

With Standard & Poor's 500-stock index more than doubling since January 1995, U.S. stock investors have been enjoying an Everest-like ascent. But when MONEY's chief investment strategist Michael Sivy and many other experts survey the Wall Street landscape, they see valleys and plateaus looming in the months ahead. So where can you look for the 15% annual gains that will double your money in five years? Today some of the most promising peaks are off the beaten path in the burgeoning economies of Asia, Latin America and Eastern Europe. "You are likely to see emerging market returns averaging 13% to 17% annually over the next five years, compared with 8% to 12% for the U.S.," says Ken Gregory, co-editor of No-Load Fund Analyst ($225 a year; 800-776-9555). Moreover, most developing country stocks are trading at reasonable levels relative to high-flying U.S. equities. Declares Gregory: "Emerging markets offer the best prices compared with growth rates for all the global markets right now."

Below we profile five outstanding funds that specialize in small markets with big potential. Before you bite into one of these peppery portfolios, though, consider your taste for risk. "It's not unusual to see these funds drop 20% to 30% over a one- or two-month period," says Bill Whitt, international funds analyst at Chicago fund rater Morningstar. For example, the Brazilian stock market, which soared 60% in the first seven months of this year, dropped 15% during one week in July on fears of currency devaluation. So don't venture into one of the funds unless you plan to hang on for the three years or more it can take to ride out sudden short-term setbacks. In addition, most financial advisers suggest that you limit your emerging markets investments to as little as 5%--but never more than 20%--of your total equity stake. (For tips on emerging markets bond funds, see "Earn up to 31%--Without Investing in Stocks," page 80.)

To help you find the best candidates, we screened Morningstar's database for diversified and regional emerging markets funds that finished in the top third of their categories over the one- and three-year periods that ended June 1 (there's one exception, which we note later in this story). We also stuck with funds that have seasoned managers and reasonable expenses. We chose five top performers: three diversified portfolios, one that focuses on Latin America and one that invests only in Asian tigers. If you're making your first foray into emerging markets, stick with one of the diversified entries. If you already hold such a fund, consider adding one of the regional specialists to your mix. Key performance data on each fund appear in the table on page 39.

--Templeton Developing Markets. Pioneering manager Mark Mobius, 60, can claim to be the Marco Polo of money managers, having launched the first open-end emerging markets fund in 1991. And his record leads the herd with a 17.4% annual average gain over the past five years. Mobius, who is based in Hong Kong and Singapore but spends 80% of his time on the road, scours for stocks that trade cheaply compared with their peers or their historical prices. His 603-stock portfolio is a virtual United Nations of the developing world: 35 countries are represented in the $5.2 billion fund, with Asia accounting for the largest stake, at 36%. But Mobius has been doing much of his recent buying in Latin America (31% of fund assets), especially Brazil (10.6%). "With the economic restructuring that's going on, Latin America offers some of the best potential right now," he says. "People don't yet appreciate just how ready Latin America is to adopt the Asian tiger economic model." Among his top picks: $2.8 billion Venezuelan utility giant La Electricidad de Caracas at 2.8% of assets and $48.6 billion Telebras at 2.6%.

--SSgA Emerging Markets. "The best way to add value is to be in the right country at the right time," says manager Robert Furdak, 34 (pictured on page 39). So Furdak practices "top down" investing: First he determines how much of the fund's $250 million in assets to invest in each country; then he seeks out the best stocks within those markets. His choices typically trade at low prices relative to their prospective earnings gains. That "growth at the right price" strategy has led the fund to a solid 9.9% annualized return since its inception in 1994. Like Mobius, Furdak favors Brazil, which is his largest country bet, at 18.8% of assets. But long term, Furdak believes the best values lie in the Asian subcontinent--India, Pakistan and Sri Lanka. He now deploys 11.3% of his assets there and plans to increase his holdings when bureaucratic hurdles for foreign institutional investors are eased. "The subcontinent has not shared the recent surge in other emerging markets, so stock prices are relatively depressed," he says. "But tax reform and many other positive economic developments will push up those markets." Furdak's top holdings include two Indian firms, $1.7 billion Hindustan Lever, a consumer-products company, and $1.2 billion Mahanagar Telephone.

--Vanguard International Equity Index-Emerging Markets. This $930 million portfolio brings index investing, the strategy of mimicking a market benchmark, to the developing world. The fund tracks a customized yardstick (created for Vanguard by Morgan Stanley) designed to represent 12 fledgling stock markets plus Hong Kong and Singapore. Morgan chose only those markets that were large and active enough for Vanguard to do the trading necessary to keep its fund properly balanced. Malaysia has the biggest share of the index, at 16%, followed by Brazil (12%), Hong Kong (12%) and Singapore (6%). "We plan to increase the number of countries in the index as the markets develop," says Vanguard equity index guru Gus Sauter, 43. Over the past two years, for example, South Africa, Turkey and Israel have earned places on the roster. So far, Vanguard's "passive" approach has been a success. Over the past three years the fund ranks 13th of the 35 emerging markets portfolios tracked by Morningstar.

--Scudder Latin America. Latin markets have made strong recoveries from the drastic declines that followed Mexico's 1994 peso devaluation. And this $1.2 billion fund has gained a fiery 35.5% in the past 12 months. To provide some protection against this region's regular market squalls, managers Ed Games, 60, Paul Rogers, 41, and Tara Kenney, 36, seek stocks with low price-to-cash-flow ratios. "Stocks with strong cash flow are best prepared to survive and grow," says Rogers. He cites $21.6 billion Mexican telecommunications giant Telefonos de Mexico and $10.7 million Argentine oil and gas company YPF, which both trade at less than six times their 1997 cash flow. Overall, eight nations are represented in the 60-stock portfolio, with Brazil claiming 43.9% of fund assets and Mexico accounting for 25.4%. The fund's 14.6% gain for the past three years puts it more than four points ahead of the typical Latin fund.

--Matthews Pacific Tiger. This $48 million portfolio won't turn three years old until September, but we include it here because managers Paul Matthews, 41, and Mark Headley, 38, have delivered such strong results. During the past two years, the fund has notched an average annual 32.31% return, vs. 8.43% for its peers. Matthews and Headley concentrate their 50-stock portfolio in nine fast-growing Asian nations, with China (including Hong Kong) accounting for hefty 44.2% of assets. They look for small and mid-size company stocks (less than $1 billion in total market value) that trade at below-average price-to-earnings ratios with above-average growth prospects. Among the fund's top holdings are $537 million Founder (Hong Kong) Ltd., a software firm, and $509 million refrigerator manufacturer Guangdong Kelon. "Conditions are increasingly favorable in China," says Matthews, who expects a gradual dismantling of the state-run economy to boost the nation's export growth--and help provide the heady gains adventurous investors hope to find when they travel to far-off lands.

ALL FUND DATA AS OF AUG. 1