Emerging world returns may not pay off: Vanguard

Just because China expects to grow at 9% while the United States is at 2% does not mean investors should favour China, Davis said.

"That may pay off, but it won't be because their expected growth rate is 9% today. That is irrelevant," he told Reuters in an interview late Friday. "The one thing I'm a little cautious about is investors equating the expected growth rate with financial returns because the correlation is zero over long periods of time."

Valley Forge, Pennsylvania-based Vanguard managed about USD 1.3 trillion in US mutual funds as of the end of 2009. The Vanguard Emerging Markets Stock Index Fund has USD 32 billion in assets.

Valuations for emerging markets were relatively low a decade ago, and as a result, these markets have outperformed US equities in recent years as growth came in higher than expected.

The bar is now higher, Davis said, and whether good returns can continue depends on factors such as market expectations and the price investors pay for growth.

"The expectations for growth in emerging markets are a little bit higher than they were 10 years ago," he said. "It does not mean 'do not be investing in emerging markets,' you should own the world."

The global economy still faces uncertainties and "skepticism" is likely to dominate investor sentiment this year, Davis said. While many economies have emerged from recession, high unemployment and foreclosure levels are still restraining growth.

He added that the BRIC nations (Brazil, Russia, India and China) have become one of the twin engines of world economic growth along with the United States.

"Broadly speaking, that's positive. Because that means if one engine fails, you still may pull it up. That also means, though, that we have to monitor those emerging markets a lot more closely in terms of their policies."

Dollar Resilience

The resilience of the US economy should help support the dollar versus most major currencies this year, Davis said.

"My confidence in the US dollar as an international reserve currency is as high as it was before the crisis," he said. "(At) the end of the day, when there's a crisis in the world, there's a flight to US assets and to US dollars."

Davis said the US economy is "certainly outperforming" Europe and Japan and that the Federal Reserve's decision last week to raise the discount rate is a welcome development.

"It's very clear that they are growing increasingly confident that this tentative recovery that we're seeing is the start of a self-sustaining one," he said.

US policymakers face a challenging task of unwinding the extraordinary policy measures put in place during the crisis, he said. On the one hand, the Fed wants to avoid being restrictive because of lessons of the Great Depression and Japan. On the other, keeping rates low too long may create inflation and put the economy in danger of another asset bubble.

Davis also said that the euro zone is at a "critical juncture over the next year" and investors will watch closely how it handles the debt troubles in countries like Greece, Portugal and Spain.

"There's some potential of them following Japan's path. I don't think it's likely, but the potential is there," Davis said. "They have a high debt problem and their economy is not rebounding as quickly as they would have hoped."