As EEM’s asset count tops $12 billion, we ask: Are emerging markets still a good deal for investors?

I’m hearing more and more talk these days about an emerging markets bubble.  It’s easy to see why.  All the markers are there: the overconfidence, the magazine covers, the dreams of never-ending 30 percent returns. I’m starting to hear stories from friends and relatives about their favorite Russian mutual funds, Indian bank stocks and Brazilian petrochemical giants. That always makes me nervous.

Emerging markets went up 56 percent in 2003, 26 percent in 2004, and 34 percent in 2005 … and those returns have grabbed investor attention, and attracted investors’ assets.  The iShares MSCI Emerging Markets (EEM) exchange-traded fund (ETF) is one of the fastest growing mutual funds in the world, with assets already over $12 billion. And it’s not the only fund doing well: So far this year — and it’s only February, remember — investors have socked $15.8 billion into emerging markets, according to Emerging Portfolio Fund Research.  That’s half as much as they fed into domestic funds in all of 2005.

Of course, as an indexer, this is all nonsense.  The most sensible investment strategy is to stay the course — to maintain a small but steady exposure to emerging market economies.  Emerging markets represent about 6.5 percent of the world’s gross domestic product, so one reasonable approach would be to assign about 6.5 percent of your portfolio to the emerging markets sector.

But the huge returns — and the huge claims made by proponents — merit further investigation.  Even indexers don’t like to get swept up in bubbles.  Are emerging markets still a good deal?  Are they way overblown?

As an added bonus, I thought I’d look under the hood of the EEM ETF, to see what exactly you get when you invest in the world’s leading emerging markets portfolio.

Are Emerging Markets A Good Deal?

It’s a rare investment that can shoot up 162 percent in three years and still be considered a good deal.  But the iShares MSCI Emerging Markets fund just might pull it off.

Thanks to strong performance by the underlying equities, and very low original valuations, the index enters 2006 trading at just 15 times trailing earnings.  For comparison, the S&P 500 trades for 19 times earnings. In fact, according to State Street Global Advisors (SSgA), the amazing run in emerging market stocks over the past three years has hardly changed the valuation of the index at all.

MSCI Emerging Markets Index