Smart picks for emerging markets

NEW YORK (CNNMoney.com) -- Stomaching the ups and downs of emerging markets can be difficult for most investors, but this asset class has a place in practically every portfolio.

While they're known for their risk and volatility, emerging markets - which range from high-profile markets like China and India to the lesser-known markets of South Africa and Morocco - have posted spectacular returns over the last four years. Since the end of 2002, the benchmark Morgan Stanley Capital International Emerging Markets Index has returned about 235 percent.

Emerging markets have been on a roll, racking up annualized returns of about 35 percent - a pace of growth that Brad Durham, a managing director at Emerging Portfolio Fund Research, thinks will be difficult to maintain. "I would not expect the same super-sized returns in the future. The returns will be positive, but more modest."

With emerging markets now in their fifth year of a bull cycle, the market may be getting ready to enter a period of consolidation, which could open up buying opportunities for investors.

"You don't want to have a very significant portion of your portfolio [in emerging markets], but that's where growth is going to be over the next decade," said Anthony Ogorek, a financial adviser in Williamsville, N.Y. who recommends clients hold 4 to 10 percent of their portfolio in emerging markets.

You're usually better off waiting for a pullback before committing dollars to investments that have had a tremendous run, according to Ogorek. Just make sure the fund hasn't lagged the market due to bad management.

But investors exploring emerging markets will want to first check what they already own in their portfolio. Most foreign funds will have some emerging market exposure, usually around 10 percent. The Vanguard Total International Index (Charts), for instance, has about 15 percent of its holdings in emerging markets.

"If you have that core holding and you still want a second fund, you should consider a complementary fund - such as a diversified emerging market or small-cap foreign fund," said Bill Rocco, senior analyst at Morningstar.

Some good choices are the T. Rowe Price International Emerging Markets Stock (Charts) fund and the Lazard Emerging Markets (Charts) fund. T. Rowe Price does a great job holding down expenses while delivering consistently good returns, and the Lazard fund has a solid track record, said Jeff Tjornehoj, senior research analyst at Lipper.

The SSgA Emerging Markets (Charts) is another good option for investors. The large-cap blend has a four-star rating from Morningstar and also made it onto Money magazine's list of the 70 best mutual funds.

Investors who don't want to wade through fund ratings and sort through manager track records might consider the iShares MSCI Emerging Market (Charts) ETF, which is correlated to the performance of the MSCI Emerging Markets Index. The ETF has an attractive expense ratio of 0.75 percent, but brokerage commissions can add up. (The pros and cons of ETFs.)

Financial planners overwhelmingly recommend broad emerging-markets funds over regional or country-specific funds. "When you're chasing performance - that's when it can get dangerous," said Tjornehoj. But if you think you're qualified or competent to make calls on country-specific firms, you should be prepared for the worst and consider areas that haven't been overbought.

Michael Hartnett, head of emerging-markets strategy at Merrill Lynch, said at a recent conference that non-BRIC investments are the way to go this year. (BRIC is a term used to describe the group of emerging-market countries that includes Brazil, Russia, India and China.) He named Korea and Vietnam as areas he's closely watching.

While emerging markets may not serve up the same dizzying returns over the next few years as they have in the past, they're still a good bet for investors who want to position themselves for the longer-term growth of these markets. "The real story for emerging markets going forward is the rapidly rising middle class and the shift of these economies toward more consumer-driven growth," Durham said.

T. Rowe Price: Bull market winner