The credit crisis, an impending recession, and fears of escalating inflation are crippling growth prospects in developed economies. Rather than settling for meager returns in these markets, investors should be aware that over the next several years emerging market equities will likely outperform their developed market counterparts, says Mark Madden, lead portfolio manager of Ninth Wave Capital, a Boston-based global emerging markets fund with $75 million under management.  Following an extreme sell-off in emerging markets, which have declined more severely than developed markets over the past year, emerging market equity valuations are now more attractive and offer higher growth prospects than those in developed markets.  They present a compelling opportunity for long term investors.

We spoke with Madden, who has nearly a quarter century of experience in emerging markets, having previously managed a $2 billion fund for Pioneer Investments and a $14 billion fund for OppenheimerFunds before starting Ninth Wave in 2007.

Madden explained that emerging market equities have been driven by different emphases over the years, with some periods dominated by a focus on industry cycles and bottom-up stock selection and others more influenced by country or macro factors.  For example, during the bull market that ended about a year ago, a sector-based bottom-up approach worked well for his fund.  Now, however, the current credit crisis has made macro-economic and liquidity considerations more important.  He believes that, over the next several years, sector and stock selection will re-emerge as key drivers of equity performance and the current dominance of macro factors will diminish in importance.  “With the global maelstrom, macro issues have become terribly important in 2008,” says Madden.

Like many other managers, he explains, Ninth Wave was long commodity companies and short consumer-oriented businesses over the past year.  By March of this year, his fund reduced its commodities exposure and began to take more long positions in severely beaten up telecom, industrial and selected financial stocks.  (He admits that Ninth Wave was early in its move to reduce its commodity exposure as oil and other commodities prices finally peaked some months later in early July.)  With commodity prices falling, and probably set to overshoot to the downside, the risks of higher structural inflation globally are diminishing, allowing central banks around the world to reduce interest rates.  That’s good news for many Asian emerging market economies, but it’s negative for commodity-producing countries.  Global growth will slowly recover over the next several years as lower commodity prices and lower inflation allow for further interest rate cuts. Emerging markets’ growth of 4-8% per year should strongly outpace the 1-2% that will likely prevail in the developed world.     

To understand how these themes play out in within the emerging markets, we asked Madden to walk us through each of the BRIC economies.

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