By Bryan Dooley

Over the past year or so, emerging market equities have been an investment pariah, regularly slammed on concerns of political upheaval, falling growth rates and financial imbalances. However, investors with a longer term time horizon should pay attention to these stocks. Value investors can likely profit over the coming years by investing in the lately beleaguered and often highly volatile emerging market sector, but success will require greater focus.

Until a few years ago, emerging market (EM) investing was synonymous with the ”BRICs”, a term coined in 2001 by former Goldman Sachs economist Jim O’Neill, that represents the largest developing economies: Brazil, Russia, India and China. Indeed, during the first ten years of this century, O’Neill’s timing proved astute as growth in these countries began to far outpace most of the industrialised Western world and the BRIC stock markets followed suit. The MSCI Emerging Markets Index, heavily weighted in the BRIC countries, provided a total return of 350 percent compared to a return of just 34 percent on the MSCI Developed Markets Index from 2000 to 2010.

Back then, the BRICs had their glory days but more recently they have stumbled as their economic models reached structural limitations. Painful transitions forced upon these once high-flying economies are now immediately apparent in Brazil, India and China. All three of these countries are presently tackling myriad political, social and financial issues mostly related their excessive credit growth over the past decade. Meanwhile, Russia’s growth is expected to grind to a virtual halt as America and its allies impose stiff sanctions in reaction to the country’s recent aggression in Ukraine.

Investors have sensed the fragility of the BRIC countries in recent months and have steadily pulled funds from the sector. Since the end of 2010 through the end of the latest quarter, the MSCI Emerging Markets Index has fallen 5.6 percent while the MSCI Developed Markets Index gained 43.5 percent. More recently, Russian stocks have tumbled 11.9 percent over the past 18 months and China declined almost six percent in the last quarter alone as the country’s previously torrid growth rate continues to cool.

The recent turmoil in the emerging market sector highlights the need for greater selectivity. Our top choices for the best markets in the years ahead are affectionately referred to by the “PIMPS” acronym: Philippines, Indonesia, Mexico, Poland and South Korea. Our rational is as follows:

Philippines – One of the few Asian economies expected to accelerate growth even as China slows. Prior to 2010, the Philippines had been a perpetually challenged economy plagued by shaky leadership. Yet over the past four years, the market has begun to catch up as the new president, Benigno Aquino III pushed economic reforms and fought government corruption. On top of its improving fiscal position, the country has a very young demographic with about half of the population under the age of 25, many of whom are English-speaking, literate and good candidates global outsourcing services. The country’s current account surplus of over two percent of GDP and high level of foreign exchange reserves set the island country apart from many other EM nations which rely too heavily on foreign capital.

Indonesia – Formerly one of Asia’s top performing markets, last year investors began dumping their holdings as the local currency tumbled. However, in recent months, Indonesia has taken steps towards reducing its current account deficit and citizens will go to the polls this year to elect new leadership. Indonesian stocks trade at just 15 times this year’s earnings, cheaper than the S&P 500, while their economy is expected to advance by 5.4 percent this year and accelerate to six percent growth next year, roughly double the growth rate of the US.

Mexico – Since the North American Free Trade Agreement (NAFTA) was implemented in 1994, Mexico’s role as a low-cost manufacturer of US products has steadily increased with exports to the US now accounting for about a third of country’s gross domestic product. With America leading world growth and outsourced production returning to Mexico from a more expensive China, the economy looks on track to be one of the best performing countries in Latin America. Furthermore, the county’s leadership has stabilized substantially since the election of President Enrique Nieto. Since taking over in 2012, Nieto has begun to tackle some of the nation’s long-standing issues, such as inefficiencies in the labor market, underinvestment in the state-owned energy sector, and the government’s high dependence on oil.

Poland – One of the few countries that weathered Europe’s economic crisis relatively unscathed, Poland remains better positioned than many of its peers in the region. With Russia invading Ukraine and annexing Crimea, investors have fled Eastern Europe putting downward price pressure on the region’s emerging markets. Assuming Russia’s ambitions remain focused on Ukraine, Poland stands out as a baby thrown out with the proverbial bathwater. The nation is not too heavily exposed to regional banking issues which have plagued other European countries nor overly dependent upon commodities. The Polish economy is expected to expand by three percent this year and accelerate to 3.4 percent in 2015.

South Korea – While analysts remain divided over whether or not South Korea is technically a developing or developed market, the rising Asian tiger is now clearly an important player on the global economic stage. In recent years, the nation has ascended to the world’s 15th largest economy ranked by nominal GDP and eighth largest product exporter. Korea has successfully incubated many globally competitive companies including Samsung, Hyundai and LG Electronics. The Korean stock market has lagged the broader averages likely because the country is still treated as a developing country despite its rising stature. The nation’s economy is expected to advance from by 3.0 percent this year accelerating to 3.6 percent in 2015.

For those investors with patience and perhaps a strong stomach, some of the more promising developing markets and individual stocks within those markets deserve a closer look.

Bryan Dooley, CFA is a senior portfolio manager at LOM Asset Management Ltd in Bermuda. Contact LOM at 441-292-5000 for further information.

This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult with their Brokers if such information and or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority.