(MONEY Magazine) – YES, EVEN IN THOSE VOLATILE EMERGING MARKETS

BY GALINA ESPINOZA

When Ron Chapman, head of international equities at the Dreyfus Corp., visited Kuala Lumpur last fall, he wanted to see the view from the top of the Petronas Twin Towers, a skyscraper that, at 1,483 feet high, reigns as the world's tallest office building. When he got to the towers, however, Chapman decided not to take the elevator past the 35th floor. "I just didn't have confidence in the building's construction," he recalls.

Today, Chapman isn't the only investor taking a closer look at Asia--and not liking what he sees. The region is wracked by a doubled-barreled economic crisis as both domestic banks and private companies falter. Meanwhile, battered markets keep sinking lower. "Trying to buy into Asia right now is like trying to catch a falling knife," says Vernon Winters, chief investment officer for Mellon Private Asset Management in Boston.

But occasional downdrafts, however fierce, don't undo the case for investing abroad. And emerging markets still offer attractive opportunities for investors who seek maximum growth and have at least a five-year time horizon. Remember the hand-wringing about Mexico in 1995? The Mexican stock market fell 22% after the peso was devalued. Then in 1996 and 1997, the market rose an average of 34% a year. Here's the case for emerging markets:

The economics of developing nations are, on average, growing twice as fast as those in the developed world. That's why investment strategists suggest allocating at least 5% of your holdings to emerging markets. "Economic growth should lead to faster corporate growth, rewarding you with higher returns," says Allan Conway, head of global emerging markets for GT Global Mutual Funds in London. In fact, over the past 10 years, the Morgan Stanley Capital International (MSCI) emerging markets index has registered an average annual return of 13.7%, beating the 11.1% average annual return notched by the MSCI world index, a composite of developed nations.

Even within Asia, where growth is slowing, individual economies are still expanding. In fact, the World Bank Group projects that GDP growth in countries like Indonesia, the Philippines and Thailand will average 7.6% a year through 2006. That's not the sizzling 9.2% annual average gain these countries enjoyed from 1987 to 1996, but it's a lot hotter than anything in mature markets like the U.S.

Concerns about Asia have driven down stock prices in most of the world's fastest-growing economies. For example, while Standard & Poor's 500 index of the largest U.S. stocks is selling at around four times book value, the stocks of developing economies are at just 1 1/2 times book value. Says Winters: "If you haven't been in emerging markets, now is a good time to get in."

Your best opportunities are in countries with declining inflation and political stability. That brings us back to Mexico and to Hungary, both of which had currency meltdowns and are now poised to rebound. In early 1995, Mexico adopted a budget so austere that the economy contracted 6.5% that year. But now the pain is turning into gain: The country's forecast 1998 GDP growth is around 5%, and inflation is expected to dip from 16% to 12%. Hungary also devalued its currency, the forint, in 1995 to curb imports and boost the competitiveness of its exports. The government then privatized state-owned industries and imposed an economic reforms that stabilized the nation's banks and . The result? Inflation has fallen from 28% to an expected 15% this year, while the economy is growing at more than 4%. Says Rosemary Sagar, head of international investments for U.S. Trust: "Hungary really cleaned up the shop and is picking up momentum."

To reduce your risk, invest in mutual funds run by experienced managers. Many experts say the best way to invest in emerging markets is via closed-end funds, which issue a fixed number of shares and trade like stocks on exchanges. The advantage: Closed-end managers don't have to cope with sudden redemptionss or bursts of new cash that can disrupt their trading strategies.

If you want to invest south of the border, Morningstar analyst Bridget B. Hughes likes closed-end Latin American Discovery Fund (ticker symbol: LDF; $10 as of Jan. 27), whose net asset value is up an average of 15% a year since 1995, trouncing the 8.7% annual average gain of the MSCI Latin America. Recently, managers Robert Meyer and Andy Skov had a 35% of assets in Mexican companies like the broadcasting giant Grupo Televisa and Kimberly-Clark de Mexico.

As for Eastern European markets, Bill Whitt, an international funds analyst at Morningstar, favors closed-end Morgan Stanley Russia & New Europe Fund (RNE; $21.25), which has averaged a 41% return (in net asset value) since its inception in September 1996. Manager Michael Hewett favors blue chips; he recently had 20% of his assets in Hungarian firms like Matav, the national phone service company. Latin American Discovery and Morgan Stanley Russia trade on the New York Stock Exchange at a discount to net asset value, which means you can buy them for less than the underlying worth of the stocks in their portfolios. Beware: If you're looking for single-country closed-end funds investing in Asia, you'll find most of them trading at premiums to net asset value, making them doubly risky; even if the stocks they hold recover, a drop in premiums could reduce or eliminate profits. Be careful which elevator you choose.

NO, THE WORLD'S BEST COMPANIES ARE RIGHT HERE AT HOME

BY MICHAEL SIVY

If you're like most investors, you've been hearing for years about the importance of diversifying your stockholdings with foreign investments. But after watching many Asian stock markets decline more than 50% from their 1997 highs, you may well be wondering why anyone would want to diversify outside the good old U.S. of A. "The Asian crisis is far from over," says economist David Malpass at Bear Stearns in New York City. "The damage is massive, and it could take five to 10 years for Southeast Asia's gross domestic product to return to 1996 levels in U.S. dollar terms."

The recent Asia debacle isn't the first time in the past decade that foreign markets have disappointed stock investors. The December 1994 collapse of the Mexican peso triggered stock market declines that cost U.S. investors in Latin America nearly 17% in 1995, a year when U.S. stocks returned more than 37%. And since the Japanese market hit bottom in 1992, that country's stocks are up a skimpy 15%, while U.S. stocks have more than doubled.

Given those results, you have to wonder why foreign investing is supposed to be so smart, especially since the U.S. economy is the strongest it has been since the 1960s and is likely to remain so for the foreseeable future. "Today the U.S. dominates all the major growth industries," says Robert Sanborn, manager of the Oakmark fund (up 32.6% for 1997). "In fact, the 10 best large companies in the world are all American." As examples, Sanborn cites Boeing, Coca-Cola, Merck and Microsoft.

Market strategists will argue that many foreign economies are growing at least twice as fast as the U.S., which figures to post less than 3% real growth in gross domestic product this year. And they'll point out that since the U.S. stock market represents only about half of the world's equity capital, you are passing up great opportunities if you ignore top foreign competitors. For example, Japan's film giant Fuji Photo has gained 47% over the past two years, while its U.S. rival Eastman Kodak has declined 5% over the same period. And the Rochester photo company still seems to be losing ground. In mid-January, Kodak announced a $744 million loss for the fourth quarter of 1997 (including restructuring charges) on a 13% decline in revenues to $3.83 billion.

But if you consider the arguments for foreign investing more carefully, you'll find that they look a lot less compelling.

Diversification overseas doesn't provide as much protection as you might think. Fifty years ago, major foreign stock markets rose and fell at different times. But today, thanks to growing world trade, faster communications and increasing flows of capital, markets are more likely to move together--especially in bad times. Consider 1990, for example, when U.S. stocks lost 3.3%. Leading foreign markets didn't provide much helpful diversification that year as they sank anywhere from twice to 11 times as much (see the chart below).

There are really two types of foreign markets, with very different characteristics. Major industrialized countries in Europe and Japan account for more than a third of the world's market capital. They aren't terribly risky and include lots of top-quality companies, but their overall growth prospects at best match those of the U.S. By contrast, emerging markets--including those in Latin America, Eastern Europe and most Asian countries--represent less than 20% of the world's total equity. These markets do have impressive potential growth rates but are small and volatile. It is rare to find a single market that combines both high growth and low risk.

You'll have a hard time getting reliable information on all but the largest foreign firms. Only the most visible overseas companies--such as Finnish cellular-phone maker Nokia, British information-supplier Reuters Holdings and Japan's Sony--are covered in the U.S. press as thoroughly as domestic firms are. In addition, looser accounting rules in many foreign countries make it difficult for U.S. investors to evaluate accurately the earnings reports and other information available on companies in most other countries.

Investing overseas exposes you to currency risk. If a Japanese company and a U.S. firm have similar prospects, they should be equally good investments, right? Not necessarily. What's important for U.S. investors is a stock's return in dollars, not foreign currencies. After all, you pay your bills in dollars, not yen, renminbi or zlotys. As a result, from a U.S. investor's point of view, foreign shares have more unpredictable returns. If the yen falls, for instance, a Japanese stock will be worth less in dollar terms. So buying any foreign stock will pose an additional risk to your portfolio.

You can safely benefit from growth overseas by owning U.S. multinationals. "The 20 largest U.S. companies get an average of 34.5% of their total revenues internationally," says analyst Jane Couperus at the Papp America-Abroad fund, which invests heavily in such stocks. For many blue chips, the importance of foreign revenues is even greater. For example, foreign business generates about 67% of sales at Coca-Cola, 60% at Motorola, 58% at Intel and 49% at McDonald's. Buying these blue chips--or a mutual fund like Papp America-Abroad (800-421-4004)--gives you low-risk exposure to the fastest-growing foreign economies.

My view is that if you want to put 10% of your total portfolio in an international stock fund such as Harbor International (800-422-1050) that holds mostly foreign blue chips or 5% of your money in an emerging markets fund such as Templeton Developing Markets (800-292-9293), go ahead. But the effect on your portfolio won't be great, although over 10 or 20 years, you might earn slightly more--say, a few tenths of a percentage point annually--than an all-American portfolio could offer.

Alternatively, if all foreign investing makes you nervous, don't bother--and don't feel bad about being a homebody. You live in the greatest stock market in the world. You don't really need any others.