The underperformance of emerging markets so far this year is unusual, but it is an excellent opportunity to invest. Sectors exposed to domestic demand and infrastructure development are particularly attractive in these markets.

The current underperformance in emerging markets versus the developed world is unusual, having occurred during a rising market environment in only one year (1996) over the past 20.

Emerging markets, which have benefited from substantial investment in recent years, including nearly $100 billion in 2010 alone, have lagged developed markets year-to-date. While developed countries continue to benefit from economic stimulus measures, emerging markets have faced concerns about inflation and monetary tightening.

They are experiencing rising cyclical inflation due primarily to a spike in food and energy prices over the past six months.

However, this period of inflation is expected to be short term in nature. Even with the increasing wages in emerging markets, core and structural inflation, which excludes food and energy prices, remains well controlled in most of these countries.

Government and regulatory authorities in India, China, Brazil and other emerging markets have already aggressively tightened their fiscal and monetary policies.

Downgrades in GDP growth estimates for China suggest that these steps have been effective in preventing economic overheating.

In fact, the positive long-term structural drivers that have favored emerging markets over developed markets remain intact. Therefore, the current performance reversal, tied to cyclical drivers, will be relatively short-lived. In fact, we have already begun to see signals of a possible turnaround.

The downturn of the past few months has created an excellent opportunity to purchase promising stocks at favorable prices.

The MSCI India Index corrected about 20 percent from its high on November 10, 2010 to a low of February 10, 2011. Although it would still be too early to call the bottom of the Indian stock market, many strategists consider the typical bull market correction to be 15-20 percent, which puts it in this range. The Indian stock market gained 7.8 percent between February 10 and March 11, which could have broader implications since India and China have been leading indicators in the past.

Analysts have begun to upgrade earnings estimates for emerging market equities as stocks have become even cheaper in recent months relative to those in developed markets. Companies linked to domestic demand and infrastructure development are still particularly attractive.

The author is a senior portfolio manager at Batterymarch Financial Management, an affiliate of global asset management firm Legg Mason. The opinions expressed here are entirely his own.

(HK Edition 04/07/2011 page2)