It's emerging that nothing is really a safe haven in crisis

WHEN equity markets started wobbling a few months ago, investors were urged to look east. The hitherto unlikely notion of emerging markets as a safe haven – particularly those in Asia – took hold, with the promise of insulation from the woes of the global economy.

Except it hasn't quite worked out that way. No emerging markets fund has been able to post a positive return over the last six months and the sector is averaging a loss of 14.3 per cent. Over that period, the global emerging markets sector ranks 27 out of 29 Investment Management Association categories. The average return over one year is still negative, at -3.1 per cent, compared with massive average returns of 68.8 per cent and 176 per cent over three and five years respectively.

The region has been hit by the slowdown in US consumer spending. According to HSBC Private Bank, exports are down 15 per cent for every 1 per cent decline in western consumption, pointing to an emerging markets downturn over the next 18 months or so. Inflation has become a global problem too, with food and energy accounting for a greater share of consumer price inflation in emerging markets countries.

So it seems that Asia and other emerging markets haven't "decoupled" from the global economy to the extent that many had assumed. Instead, the dependence of Asian exports on the US consumer has been exposed and their markets have broadly followed those of developed countries.

"Demand between the Asian countries is only because of western demand, so as the retail sector slows down here, the credit crunch is feeding through to Asia," explained Adrian Lowcock, senior investment adviser at Bestinvest. "It's all interlinked and nowhere is immune to it."

The typical fund in the Asia excluding Japan sector is down 18.1 per cent over six months and 9.6 per cent over the year, making it the worst sector over the last half year. A closer look at funds in the sector reveals that the underperformers typically have more exposure to China (and to a lesser extent, India) than their outperforming peers.

However, Claudia Barrulas, client portfolio manager for theJPMorgan Emerging Markets Investment Trust, said that, despite concerns over the impact of the economic slowdown, emerging markets as a whole still outperform developed countries. "The main drivers are domestic demand and consumption growth coming from within emerging markets," said Barrulas. "Infrastructure spending and commodities have been playing an important role and are part of a theme that we expect to continue to deliver over the mid to long-term across all regions."

The biggest risk to emerging markets is a commodities blow-out. The regions with the greatest natural resources, such as Brazil, Russia and Argentina, have benefited from the current environment and there are four Latin American funds in the top five across all sectors over the past five years. But that region is very commodities-driven and most funds have particularly heavy weightings in Petrobras, the Brazilian oil group. "There is very little diversification and performance depends on one or two companies," said Lowcock. "Growth in both Latin America and Russia is very commodities-based."

Of course, opinion is split on the nature of the commodities surge. "If there is a bubble then clearly there would be serious problems when it bursts," said Marcus Brooks, investment director at Edinburgh boutique Cornelian Asset Managers. "But, while the oil price should come back down a bit, we don't believe there is a bubble."

Nevertheless, the emerging markets story is one for the long haul and a key player in effective diversification, according to Lowcock. "There is still a growth story there but markets remain closely correlated. The decoupling argument that the region's demand will outstrip exports is not true yet, but the expectation is that it will happen eventually."

Emerging-market economies will continue to grow, not only because of their demographics but because of the commitment of China, India and Russian in particular to infrastructure development and consumer-oriented services.

For private investors, achieving balanced exposure to emerging markets isn't straightforward, due to the extent of indirect exposure through other funds, such as natural resources. But If you want to pull back from emerging markets while retaining exposure to them, opting for broader, more diversified funds is recommended, as is focusing on the long-term.

"There's a lot of overlap between Asian and emerging markets funds and some global funds," pointed out Meera Patel, a senior fund analyst at Hargreaves Lansdown. "But managers of global funds are able to diversify more and avoid the areas that aren't doing well."

Patel likes the Rathbone Global Opportunities fund, which doesn't invest directly in emerging markets but indirectly through companies with operations in developing areas.