Investing in Emerging Markets the Smart Way
November 15, 2010
SAN DIEGO (ETFguide.com) – Even though emerging markets have been hot performers the typical mutual fund investor hasn’t been getting their fair share of that sizzling performance.
That’s because according to Standard & Poor’s 2010 Scorecard of active funds vs. indexes, a decisive 85.94% of all actively managed emerging market mutual funds have been handedly beaten by the S&P/IFCI Composite, a benchmark of emerging market stocks. Here’s the translation: If investors would’ve just bought an index fund or index ETF they would’ve done better!
Moreover, even though emerging markets offer the potential for high returns, the average annual expenses for mutual funds following this category are a very steep 1.76% according to Morningstar data. In contrast, the median expense ratio for emerging markets ETFs is just 0.65%. Put another way, choosing ETFs over actively managed emerging markets mutual funds will save you more than 60% in needless annual fees.
Let’s evaluate four strategies for investing in emerging markets:
An investment like the Vanguard Emerging Markets ETF (NYSEArca: VWO) is one of the easiest ways to invest in fast growing economies around the world. VWO offers market exposure to mega developing countries like Brazil, China and Russia. The fund also charges annual fees of just 0.27% which is around 85% lower versus comparable emerging market ETFs.
The main advantage of a broadly diversified emerging market ETF is it generally avoids single country or regional blowups that sometimes occur.
Instead of trying to guess which individual countries within a certain region are going to outperform their peers, investing in the entire geographic area might make sense.
State Street Global Advisors has regional ETFs that follow emerging countries in Europe (NYSEArca: GUR), Latin America (NYSEArca: GML), Middle East and Africa (NYSEArca: GAF) and Asia Pacific (NYSEArca: GMF). All of the funds charge 0.60% annually.
People willing to risk their money on the performance of stocks within a certain country have plenty of ETF choices.
For example, BlackRock through its iShares unit now offers 31 single country ETFs and 19 dedicated to emerging countries. The largest of these is the iShares MSCI Brazil Index Fund (NYSEArca: EWZ) which has produced head turning returns of 18.85% over the past ten years.
Many single country emerging markets ETFs actually double as industry sector bets since they tend to be concentrated in commodities, energy or other top sectors of their respective country.
Certain fund providers like Van Eck Global offer exposure to Russia (NYSEArca: RSX), Indonesia (NYSEArca: IDX) and Poland (NYSEArca: PLND). Most individual country ETFs will have expense ratios between 0.50% to 0.90%.
Leverage and Shorting Strategies
One final way to capitalize on emerging markets is by using funds or ETFs that attempt to magnify their performance (leverage) or funds that increase in value when emerging markets decline (short).
For example, super bullish traders who want the potential for magnified gains in emerging market stocks but without using a margin account should consider the DirexionShares Daily Emerging Markets Bull 3x Shares (NYSEArca: EDC), DirexionShares Daily Latin America Bull 3x Shares (NYSEArca: LBJ) or the DirexionShares Daily India Bull 3x Shares (NYSEArca: INDL).
Traders or investors with a bearish view should look at the opposite trades of those mentioned above; the DirexionShares Daily Emerging Markets Bear 3x Shares (NYSEArca: EDZ), DirexionShares Daily Latin America Bear 3x Shares (NYSEArca: LHB) and DirexionShares Daily India Bear 3x Shares (NYSEArca: INDZ).
As the names for all of these funds indicate, they aim for daily leveraged returns and for that reason are best used as short-term trades not long-term investments.
Unless you're a momentum trader it's probably unwise to be chasing the hot performance of emerging markets. A better strategy is to wait for pullbacks before adding long positions.
Likewise if you've owned emerging markets stocks and they've become a larger portion of your investment portfolio's asset allocation because of the runup, don't forget to rebalance your portfolio back to its original target asset allocation. This is a disciplined way of locking in your profits while deploying your money into other areas that may be poised for future gains.