Emerging Markets on the Rise

Investors are moving substantial sums out of bond funds and into emerging markets, much to financial advisers' delight.

In a move typical of a recession, investors plowed money into bond funds for most of this year in search of relative safety. In his fund-flow report for November, David Falkof, a Morningstar fund analyst, said net inflows to bond funds soared to more than $40 billion in August, September and October. But by November investors appeared to be "easing up on the fixed-income" pedal, with inflows for taxable and municipal bond funds dropping to $33 billion.

The money appears to be heading toward one of the riskiest classes. "Investors are still risk-averse," Falkof said, but they are also "trying to make up for lost ground in the last year or so, jumping into international stock funds."

International equities can offer much higher returns for investors — and generate much more revenue for financial advisers, whether they are paid on a fee basis or on commission.

Fee-basis advisers are benefiting from the near-70% rise in emerging markets this year. Though such advisers are probably not charging transaction costs to move money from bonds to international stocks, they are charging a flat fee based on total assets under management, said Burt Greenwald of BJ Greenwald Associates in Philadelphia. And those assets, clearly, are rising even without any new money.

For advisers working on a commission basis, the management fee is generally higher on international funds than on domestic funds. The typical bond-fund fee, Greenwald said, is 30 basis points, but the typical fee on an international stock fund is 75 basis points. From the higher fees on international funds, advisers do have to pay for higher research costs, however, such as those to develop sources on the ground or for databases to receive continuous updates about the countries in which advisers are investing.

Advisers also benefit when investors transitioning from bonds to emerging markets move outside of fund families. By and large, if investors move from a bond fund in one family to international equities in another, they will most likely be charged extra. If they stay within the same fund family, they may not.

Switching advisers to someone more expert in international stocks benefits certain advisers but hurts the ones formerly managing the money, said Christopher Maxwell, the president of Maxwell Associates.

And the trend is not without risks even to the advisers benefiting from it. If the dollar reverses itself, the logic goes, then the upside in international stocks could be short-lived. "You can change risk, but you can't get rid of it," Maxwell said.

Still, the recent re-emergence of many investors who have simply been waiting out the financial crisis may be the overriding bullish factor for advisers and their clients.

"Emerging-market funds are sexy and attractive. They are the only sector of the entire equity market that has attracted net new money this year," Greenwald said.

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