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Despite recent upheavels, pension funds remain committed to em-erging market investment with any change requiring an overhaul of est-ablished portfolio management theory. Tactical allocations have changed but strategic allocations remain unaltered, according to analysts.

There is evidence of a difference between tactical and strategic allocation," says Mark Archer of Baring Asset Management in London. "In-vestors are clear that the Central and Eastern Europe and Latin American funds are healthier."

Investment bankers, consultants and pension fund managers stress that conventional theory still applies. "If you are investing in emerging markets, you need a diversified portfolio, you need a long time horizon and you need to be prepared to be patient," says John Ross portfolio strategist with Fidelity in London.

"Investors should realise that when investing in emerging markets that they are more volatile and more risky than a developed market," he adds.

This sentiment is echoed by Rob Hall, a senior research analyst responsible for emerging markets manager research at Frank Russell in London, who says that it puts into stark reality some of the characteristics of the asset class, but does not herald a move away from such investments.

"Our US clients are more cautious about Asia but not in the sense of pulling their allocations."

Hall says that he is still receiving calls from US and European clients looking for new or additional emerging market allocations. "Part of the reason is that from a strategic point of view, they still feel they have to make the allocations."

Tactically, however, pension funds are making changes. Peter Werme, a portfolio manager at ABB investment management in Zurich, which manages part of the ABB pension fund in addition to other clients, says that they are retaining a huge cash position in the Asian markets of up to 33%.

Nevertheless he believes that the market represents a good long term bet. "The markets are going to suffer short term. It will be more expensive to borrow money in emerging markets in general so the financial situation will be quite difficult. I am pessimistic but not if you look at a longer horizon past the next six months and up to five years from now."

Patrick Roeder, head of asset management at the DM9bn ($5.1bn) Hoechst pension fund in Frankfurt says that his fund remains wary of the lack of transparency and the greater threat of insider dealing - among other pitfalls - in emerging markets.

"We have only a tiny exposure to South East Asia equities so our policy is in no way affected. We concentrate much more on the developed markets and on stocks that benefit from the growth in emerging markets instead of on the markets themselves."

However Hall believes that most funds are still committed to the asset class. "If you do not invest in emerging markets, from a strategic point of view you are taking a bet in favour of developed markets," he says.

In addition, more funds require em-erging market exposure as a consequence of using the MSCI as a benchmark. "Our clients have taken the long term view that the rational still exists for the asset class."

He adds that performance delivered by managers may be much higher than the indices would suggest. Up to September, he says, the average manager in his universe was 9% ahead of MSCI, while the median was at 16.5% as active managers were delivering still better returns.

"The quality clients, even with the sell-off in October and November, will still be sitting on positive and quite decent returns."

Investment managers have mixed opinions of how competition be-tween emerging market regions will play out. "There will be a redirection of funds, particularly to Central and Eastern Europe and this is a strong endorsement," says Archer.

Hall agrees with this suggestion, based on his belief that institutions will continue to expand their emerging market holdings. "If, in general terms, more people are funding glo-bal emerging markets mandates, then that will benefit Latin America and Europe at the expense of Asia."

However Archer also suggests that there will be an element of all markets being tarred with the same brush. In Brazil and Russia currencies are under pressure with bond spreads widening while investors in liquid markets have been locking in profits.

"Tactically we are looking for lower returns over the next six months, but longer term things are brighter where governments are prepared to take harsh medicine.

Ross is the most cautious about Eastern Europe saying that Fidelity are not heavy investors for reasons of poor liquidity, a lower number of companies, and lack of transparency. "It is very difficult in some cases to know the true state of affairs. For that reason we have tended to shy away from investing significant amounts of money although there are attractive opportunities on a selective basis."

"If you are going for a region, we would still prefer areas in Latin America but it is terribly difficult to time these markets well. You really should have a varied portfolio."

Turning to Asia specifically, managers use the example of the Mexican peso devaluation to show that markets ridden by fundamental problems can be turned around as a crisis spurs reform.

Ross says: "The IMF going into Thailand, Indonesia and South Korea, probably means that the long term structural problems will be dealt with."

However short term, he says, it is difficult to see where the marginal buyer will come from. "People should be aware that even in Mexico, it took a while for the economy and the stock market to recover," he cautions.a

Archer adds: "Asia has got to prove itself. The big question is when do you go back in.""

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