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What's Inside Those Diversified Emerging Market ETFs?

  +Follow September 19, 2013 8:29AM
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Emerging markets are notoriously unstable. If they weren’t, they’d just be called “markets.” Between their illiquid exchanges, rollercoaster currencies, and proclivity for experiencing sudden political instability, the value of an emerging market can be decimated in the blink of an eye. A developed-market investor puts their money in an emerging market at their own risk, as one is always one catastrophic macro development away from suddenly losing their (emerging market-manufactured) shirt.

Of course, investors aren’t all stupid, and they wouldn’t sink so much into emerging markets if the potential for exponential growth wasn’t so tantalizingly possible. Like a penny stock, betting on the right emerging market at that early stage of growth can be a cheap way to realize gangbusters profits.

But it’s not always an all or nothing proposition. There are ways of investing in the concept of emerging markets without throwing all your chips in one country’s emerging (read:uncertain) economic future.

Investing in Emerging Markets: Playing it Safe Through Diversification

Many emerging markets opt for semblance of a safety net by investing in a broad emerging market ETF like the mega-popular iShares MSCI Emerging Market (EEM) . This diversified ETF has investments spread out among companies from South Korea (Samsung, Hyundia); Taiwan (chip manufacturer Taiwan Semiconductor); China (China Mobile ltd (CHL) , China Construction and internet investor Tencent Holdings); Russia (Gazprom) and Mexico (telecom giant American Movil) and smaller holding in Brazilian, Turkish, Indonesian Indian and Polish interests. In short, pretty much the entire gamut of emerging markets patronized by American investors.

In a testament to an overall down year for emerging markets, the fund is down 8.63 percent on the year, though it did spike on news of the continuance of QE3. For such a wildly diversified fund, its down year is a bit of a shock. But less so when you consider how battered some individual emerging markets like India and Turkey have been this year.

Another popular, well-diversified Vanguard FTSE Emerging Market ETF (VWO) . This ETF contains 928 stocks, of which the 10 majors are the same major players: Taiwan Semiconductor; China Mobile; Gazprom; and Tencent Holdings; along with heavier stakes in Brazilian iron ore company Vale SA (VALE) and gas giant Patroleo Brasiliero. Vanguard is down 3.50 percent on the year.

A Journey Inside Your Diversified ETF

Those ETFs cover a pretty broad swath of the concept of emerging markets. But it’s interesting to note they’re heavily invested in some of the same specific countries, specifically certain industries (energy, social media, manufacturing) within those countries.  

Often, emerging market investors view their holding as being an investment in the country itself. And while it is impossible to separate the home country from the corporation within it, it is also not entirely accurate to talk about investing in emerging markets like it’s not usually investing in one or two specific strong industries within it.

Let’s say an investor is interested in singling out one of these emerging markets. Let’s say further, then, that this curious emerging market want to know what to watch for in each emerging market. In each one, there are some key developments to watch out for as we approach the fourth quarter of 2013.

Investing in a solitary emerging market is far riskier. But again: greater risk, greater reward… you know the story.

When parsing the diversified emerging market ETFs into their component countries, there are a few things investors can keep in mind.

The most developed of the emerging markets are called the BRIC countries, as they are Brazil, India, China and Russia. If an investor wants to bet on one specific emerging market, these are the favored bets.

Investing in Brazil: Look to China, Actually

Brazil and China are very close trade partners, and China is in the midst of an ongoing boom that, despite what the bears have long predicted, seems to show no signs of letting up. While an emerging market investor focused on Brazil can pay attention to the status of the country’s own domestic strife, of particular note is how China’s good fortunes trickles down to Brazil. Vale, especially, benefits greatly from Chinese growth, as the iron ore exporter is spurred on by the ongoing Chinese construction boom.

Perhaps the most popular way to invest in Brazil is via the iShares MSCI Brazil Capped ETF ($EWZ). In addition to oil and iron ore, this ETF is also closely tied to the Brazilian financial sector.

Investing in Russia: Look to European Gas Usage

Both the diversified ETFs and Russian-centric ETFs like Market Vectors Russia ETF Holdings ($RSX) are heavily sunk into Russian gas companies like Gazprom and Lukoil. The companies generate significant revenue via exports to Europe.
So Russian emerging markets will grow as their developed neighbors to the West recover, and once again begin importing large amounts of oil from Russia.  

Investing in India: Look to Reform in the Financial Sector

This country has been perhaps the hardest hit of the BRIC countries this year, India has watched their economy tumble in 2013. The rupee has lost a considerable amount of its value, inflation has been increasing exponentially, and corporate reforms are badly lagging behind more sophisticated economies.

The country has installed “academic rock star” Raghuram Rajan in charge of their Reserve Bank, and he has already begun instituting changes to the country’s banking system that will greatly modernize the country’s economic situation. One of the main goals of the reforms, notably, is enticing foreign investment.

The most popular Indian ETF is probably WisdomTree India Earnings Fund ($EPI).

Investing in China: Look to Trade Data and Apple

Ask a hundred analysts what’s really going on in the Chinese economy and you’ll get a hundred answers. What an investor in the Chinese market has to pay attention to is the trade data the government periodically releases.  This data is so important it affects American markets significantly.

Chinese telecom China Mobile is also of keen interest, especially considering their long-developing talks with Apple about making their network iPhone-compatible. Were that deal to come through, it could mean big things for the telecom giant. 

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions.

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  +Follow September 19, 2013 8:29AM



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