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Do Or Die

Investment Themes for Emerging Market ETFs (Part 2)

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Hi,

 

As mentioned this crisis in stocks is different in the sense that the sell-off has been triggered by global events. More specifically the risk has been transferred from corporates to the sovereigns. In past investors used to rotate money from leading industry groups to defensive industry groups. However, this time a lot of investments are being rotated from the developed markets to the emerging markets.

 

Before deciding to invest/diversify in emerging markets at all it is worth to look at some other significant factors. Historically emerging markets tend to pose more risk during recession. One way of measuring investors’ perceptions of the riskiness of a country’s stock market is to look at how risky the country’s debt is. This can be quantitatively indicated by sovereign credit default swap (CDS) spreads. CDS spreads measure the cost of insuring against the possibility that a country will default on its debt, i.e. they are a measure of the extent to which a country has sovereign debt problems. The wider a country’s CDS spreads, the more likely the investors think that country will go bankrupt, and the more nervous the market is about that country.

 

Let’s look at the current situation. From January 2010 to July 2011 (bull market), the average five-year CDS spread for developed markets in the MSCI ACWI index increased 206% to 263 basis points (bps); as a comparison the average spread for emerging markets actually decreased by 9% to 132 bps. At the end of January 2008 (bear market), in contrast, the ten developed world countries for which such data was then available had CDS spreads of less than 45 bps and were all among the 11 countries perceived to the be the least risky.

 

Core eurozone economies such as Germany and the Netherlands still have relatively narrow CDS spreads.

MSCI Germany (EWG)

Market Vectors Germany Small Cap(GERG)

iShares MSCI Netherlands Index (EWN)

 

The other factor could be London Interbank Offered Rate (LIBOR), levels which can spook the US/UK markets. LIBOR has been trending higher in recent weeks with a change of +17% compared to previous month. A similar sudden rise in April 2010 triggered the largest price drop in last year.

 

So now coming back to investing in emerging markets, the strongest theme could be:

Domestic-demand Driven Economies

These are China, India, Indonesia, Singapore and Japan. These economies are driven mostly by domestic demand and are thus isolated from some of the slowing global growth trends. Relevant ETFS are:

  • iShares FTSE/Xinhua China 25 Index Fund (FXI)
  • iShares MSCI Hong Kong Index Fund (EWH)
  • iPath MSCI India ETN (NYSEArca: INP)
  • WisdomTree India Earnings Fund (NYSEArca: EPI)
  • iShares S&P India Nifty 50 (NASDAQ: INDY)
  • CurrencyShares Japanese Yen Trust (FXY)
  • Indonesia Index ETF (IDX)
  • MSCI Indonesia Investable Market (EIDO)
  • iShares MSCI Singapore Index Fund (EWS)
  • First Trust ISE Chindia Index Fund (FNI)

 

EGShares Emerging Markets High Income Low Beta ETF (HILO) is worthy of notice. The index consists of 30 stocks drawn from a 2500-company and 21-country universe. The top five are Malaysia with 18.0%, South Africa 17.3%, Brazil 13.4%, China 12.7%, and Thailand 8.9%. Sector-wise, HILO is heavy on telecommunications, infrastructure and utility stocks – much like dividend ETFs from developed markets.

 

Infrastructure needs of BRIC:

The four countries are similar only in their need for increased infrastructure spending. Using World Bank data, India appears to be the least developed, and most hard-pressed to develop infrastructure (China has the best). There is no Russia specific infrastructure ETF.

EGShares INDXX Brazil Infrastructure Fund (BRXX)

EGShares INDXX India Infrastructure Fund (INXX)

EGShares INDXX China Infrastructure Fund (CHXX)

 

The PowerShares Emerging Markets Infrastructure Portfolio (PXR) has market cap of $168.2 and holds equities in a diverse selection of countries including: China (13.3%), South Africa (11.3%), Taiwan (10.2%), Brazil (9.2%), Hong Kong (7.1%), Indonesia (6.7%), Malaysia (6.6%), Russia (5.3%), Chile (4.5%), and the United States (4.3%).

 

iShares S&P Emerging Markets Infrastructure (NASDAQ: EMIF) contains exposure to China, Brazil, South Korea, Czech Republic, Mexico, Russia and Chile.

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