What’s the play with emerging markets?

Emerging market stocks and bonds have taken a hit, putting yet another dent in investor’s portfolios already suffering from recent volatility. But according to several recent stories, fund managers are finding some areas that look promising.

Here’s the Wall Street Journal’s take on the recent developments in emerging markets:

The recent rout in emerging markets is enticing some investors to jump back in to search for cheap stocks, bonds and currencies. But the selloff is prompting these bargain hunters to be a lot pickier than in the past.

Markets from Brazil to China have tumbled since mid-May amid growing expectations that the U.S. Federal Reserve is preparing to end its $85 billion in monthly bond purchases. That would shut off a flow of easy money into emerging markets just as prospects for economic growth in some of them have begun to dim. On Tuesday, the International Monetary Fund cut its outlook for the global economy in 2013, citing flagging growth in emerging markets as a major reason for the downgrade.

Investors who are buying have a different take. They say two months of outflows have cleared away much of the “hot money”—from hedge funds and other investors with a short time frame—that had pushed asset prices higher. They see little change to what attracted them to these markets in the first place: faster growth and higher yields than can be found in the developed world.

“In some places, the correction has created opportunities,” said Michael Gomez, co-head of Pacific Investment Management Co.’s emerging-market portfolio management team.

The assets faring well this month, from the Mexican peso to Middle Eastern stocks, have little in common, underscoring how the potential withdrawal of central-bank stimulus is forcing investors to be pickier about what they buy.

In this rethink of emerging markets, investors are embracing countries that have improved their balance sheet and don’t rely on outside funding for growth.

CNBC reported that emerging markets do still have some challenges to work through even as investors consider putting money back into those countries:

Fitch estimates that 2012-2013 will see the second weakest growth for the BRICs (after 2009) since the Russian crisis in 1998. Weaker China growth, declining credit growth and structural bottlenecks are among the culprits, Fitch said.

Emerging market companies also will have to adjust to this new normal. “The end of the commodity boom will be a sea change for emerging-market companies,”AllianceBernstein’s Sammy Suzuki wrote in a blog post. “In the past, they could throw capital at low-return projects and get bailed out by unrelenting economic growth. Those days are gone.”

Already emerging market companies have had trouble increasing their earnings, said Delaney of UBS.

“Despite faster-growing GDP than the developed world, the emerging markets have not managed to translate it into superior earnings growth, and in fact, we have had zero earnings growth in the emerging markets in the last two years,” she pointed out.

Even developed companies like Oracle and Accenture have struggled amid slowing emerging markets growth and an analyst downgraded IBM on concern growth will falter in the near term.

The Financial Times story focused on China and how the potential for slower economic growth will likely have ripple effects on the rest of the world:

The important message from the Chinese authorities is that they want the pace of credit expansion to slow and are cracking down on banks and shadow banking activities to achieve that goal. The result is likely to be slower economic growth. Given the state’s grip on the financial system, a crisis would probably take the form of a sharp increase in the number of zombie banks rather than a Lehman-style bank failure. But the net result, again, would be lower growth in credit and gross domestic product.

Chinese growth is already slowing and, according to many economists, by more than the official forecasts. The government’s stated policy is to rebalance the economy away from investment towards consumption, which will also suppress growth in the short term.

A credit crunch would clearly exacerbate the trend, but the direction of travel is already apparent. This is why investors are liquidating positions that benefited from China’s rapid economic expansion. Some of the unwinding has been going on for some time. Copper, for example, peaked two years ago. References to the end of the commodity supercycle are as common as those to China’s credit crunch.

Volatility at the end of June caused many investors to look for ways to find better returns in a low interest rate environment. Stories like these are always timely, especially as emerging markets move to become more established. As more investors consider putting money abroad (and are sometimes encouraged to for diversification), balanced coverage of the countries and their growth prospects helps provide people with a clear perspective of where to go in the search for returns.