Despite recent turmoil in the credit markets, confidence in prospects for emerging markets remains high. By Nicholas Lockley.

“The trend is your friend” as analysts of all shades are wont to observe. It's a message that has not escaped international buyout groups focusing their sights more intensely on emerging markets as activity in their core territories has slowed. Booming markets, built on solid economic growth, mean straightforward exits by IPO or to confident corporates emboldened by a climbing share price.

Emerging markets equities advanced 33.5 percent this year to October, dwarfing far more modest gains for most developed markets during that period, according to ratings agency S&P's analyst Alec

Young. While there are concerns about whether the rally will be sustained, S&P expects emerging markets to continue to outperform.

S&P's bullishness is based on the growing global economic clout of emerging markets. As their domestic demand has soared and trade among developing nations and with Europe has increased, emerging nations are less reliant on exports to the US, and less vulnerable to a housing-driven US slowdown.

This is fuelling strong earnings gains, which, combined with low relative valuations, is likely to maintain healthy returns.

According to data from the International Monetary Fund (IMF), in 2006 emerging economies like China, South Korea, India, Brazil, Mexico, Russia, South Africa and others accounted for 48 percent of global gross domestic product and 69 percent of global GDP growth. Young says this trend has continued to accelerate in 2007.

GDP growth is similarly encouraging. Established economies like the US and UK struggle to rise above 2 percent, while emerging market countries are tripling that.

By 2050, the United Nations estimates the working age population (15 to 64 years) of developing countries will climb to 5.1 billion, up 52 percent from 3.37 billion in 2005. Conversely, the developed world's labour pool will decline by 11 percent to 730 million from 823 million in 2005.

Standard & Poor's Equity Research believes favourable demographic trends, increased industrialisation and urbanisation, and growing consumption of finished goods and services are responsible for the shift in global growth leadership. It expects these trends to continue for decades to come.

Small wonder London-based buyout firm Permira's last two deals have been in China and Japan. The firm says this is just coincidence. But as its home turf of Europe slows, it can look forward to the opening of a Hong Kong office in six months while its Tokyo office has just cracked its first deal – the region's largest – in two years.

Antonio Bonchristiano of Brazil's GP Investments, meanwhile, is toasting a new $1.3 billion (€917 million) fund which closed last month – the firm's second such fund targeting deals in the Latin American region. Also last month, Mid Europa Partners closed its latest Central and Eastern European fund on a record-breaking total (see Privately Speaking, page 52). There are plenty of other examples.

Of course, no summary of investment prospects would be complete without acknowledging that assessment of risk remains absolutely central to any strategy encompassing emerging markets. Indeed, amid the liquidity crisis, this is a particularly pertinent consideration.

The Institute of International Finance (IIF) recently estimated that private sector capital flows to emerging markets would reach a record high of $620 billion in 2007, but would fall to $593 billion next year. Though only a small decline, it would provide evidence that the credit crunch has had an impact – the IIF attributes the tail-off to commercial banks feeling queasy about lending after the global market turmoil.

There are also concerns about the fiscal strength of some emerging markets in Central and Eastern Europe – although in Asia an improving macro-economic picture is increasingly characterised by solid fiscal positions and burgeoning foreign exchange reserves.

Small wonder emerging markets are becoming an increasingly vital private equity destination. Mega-funds may still struggle to invest consistently in emerging regions, because the average deal size is too small. But occasional landmark deals will be an important part of the mega-fund investment mix, while a vibrant mid-market of domestic and pan-regional international firms flourishes. And then there's venture capital investment, buoyed by vibrant stock markets.

The emerging market trend has plenty of friends – and is winning more as each year of rapid growth passes.