Today's post comes from an up and coming young analyst, Kelly Andrew. Kelly has been a student of the markets for some time now and writes for A&M Equity Research. Today he shares some of his knowledge with an analysis of potential emerging market investments. In last month's newsletter you probably read that emerging markets were hit hard with the recent market correction. As many of you already know when something sells off it means it goes "on sale." And we love to buy things on sale! Feel free to reach out to Kelly or myself for more info on any of the investments mentioned below. This is not a solicitation to buy or sell any of the securities below. Every investment carries risk. Take it away Kelly!
Harry Markowitz… Does this name sound familiar? Unless you were enrolled in a portfolio theory class in college it probably doesn’t. Yet many of us have heard about the importance of portfolio diversification. Let’s take a quick flash back to the 1950’s. At the time, Harry Markowitz was an American economist who studied the effects of asset risk, return, correlation and diversification and their effects to the overall return of a given portfolio. Markowitz brought forth many insightful notions about investing, but one of his most famous was Modern Portfolio Theory, or MPT. In laymen’s terms, MPT suggests that a collection of investment assets has an inherently lower level of risk then a stand-alone asset. This is due to the competitive nature of the markets and is tied to the proverbial saying; don’t keep all your eggs in one basket. Furthermore, investors should look into investing in the broadest possible global portfolio to achieve the greatest amount of diversification.
At this point you may have figured out where this article is going, or you may still be wondering what any of this has to do with emerging markets. By adding emerging market investments to a portfolio, an investor can benefit from the potential high growth returns these investments offer while further diversifying and, by theory, lowering the overall risk of the said portfolio. Another reason to invest in emerging markets is that they are quickly becoming the driver of global growth. In fact, GDP growth rates in developing countries are at least 2 times greater than rates in mature countries – and in an efficient market, this should directly translate into increased earnings growth for investors. Prior to the 2000’s it was hard for individual investors to invest in foreign markets, but thanks to the recent increase in exchange traded funds (ETF’s) it has made it easier for investors to diversify their portfolios with foreign investments.
With all this being said, let’s look into some of the top Emerging Market ETF’s available today. After a recent sell off due to increased global tensions and economic worries in some of the major foreign economies, many of these funds are starting to look oversold - this creates opportunity for investors looking to reallocate funds into emerging markets.
BLDRS Emerging Markets 50 ADR Index Fund
BLDRS Emerging Markets 50 ADR Index Fund is a PowerShares fund that is linked to the Bank of New York Emerging Markets 50 ADR Index. The fund holds 100% stocks and owns exactly 50 companies, hence the name. The majority of the shares are held in giant and large cap companies. A few of the highlighted firms are: Taiwan Semicondictor Mfg Ltd, China Mobile Limited and Baidu Inc. These may not be household names to you but around the world they are huge. While 50 stocks might seem like a lot, in the world of ETF’s this is actually very low compared to the other funds. For example, the next fund we are going to look at holds over 600. The fund’s expense ratio is 0.30% which is in line relative to its peers.
Schwab Emerging Markets Equity ETF
Schwab Emerging Markets Equity ETF is linked to the MSCI Emerging Markets NR USD Index. The fund holds 91% non-us equities and is diversified over 22 emerging market countries. All of the fund’s holdings are focused in Giant and Large Cap companies. This is a “cap-weighted” index, which means this fund picks its stocks based on size. One issue with this type of index is it can become very dependent on the largest companies in that index. Therefore, 60% of this fund is concentrated in 4 countries (China, Taiwan, Brazil and India). A few of the highlighted firms are: Taiwan Semicondictor Mfg Ltd, Tencent Holdings and China Construction Bank Corp. This funds expense ratio of 0.15% and is one of the lowest relative to its peers.
iShares MSCI Emerging Markets Minimum Volatility ETF
iShares MSCI Emerging Markets Minimum Volatility ETF linked to MSCI Emerging Markets Index but is designed to follow the observed-phenomenon that less volatility relates to higher returns over the long run. The majority of the shares are held in giant and large cap companies and holds over 200 individual stocks. A few of the highlighted firms are: Philippine Long Distance Telephone, China Mobile Limited and KT&G Corp. This fund is diversified over many sectors with the top three holdings being in Financial Services, Communication Services and Technology. The fund is more expensive relative to its peer group due to its more complicated “Minimum Volatility” strategy. The question is do you believe this strategy will provide enough “Alpha” or additional return to justify the additional cost. So far, year-to-date, this hasn't occurred.
SPDR S&P Emerging Markets Small Cap ETF
SPDR S&P Emerging Markets Small Cap ETF linked to S&P ® Emerging Markets under USD $2 Billion Index. The funds weighted average market cap is $993.69 million which puts its fund focus in the small to midcap range. This allows it to tap into the higher growth potential of smaller firms in comparison to larger firms. The fund holds 96.90% equities and is diversified over 835 companies. A few of the highlighted firms are: IGB Corp Bhd, JSE Limited and Mondi Limited. This fund is diversified over many sectors with the top three holdings being in Financial Services, Information Technology and Industrials. The fund is more expensive relative to its peer group, as smaller stocks require more analysis and management. Keep in mind smaller stocks tend to carry more risk versus their large cap counterparts but with the additional diversification of over 800 individual stocks some of that risk is diversified away.
PowerShares Emerging Markets Sovereign Debt Portfolio
PowerShares Emerging Markets Sovereign Debt Portfolio invests in Government bonds in Emerging Markets and is tied to JPM EMBI Global USD. It is a blended bond portfolio meaning that its bond holdings have varied maturities. 20-30 year maturities make up the highest percentage of bonds in this fund (36.01%). Its average coupon rate is between 6% - 8% and this range makes up 57% of the bonds. The average credit quality of the bonds in this fund is BB. Even though these are government bonds, there is still risk. Governments around the world can be even less stable then some large US companies. And the longer maturities mean it also has interest rate risk. Meaning if interest rates start to rise around the world some of these bonds could be hurt. The fund has an average expense ratio, at 0.50% which is relative to its peer group.
iShares Emerging Markets High Yield Bond Fund
iShares Emerging Markets High Yield Bond Fund invests in Government and Corporate debt securities in Emerging Markets and is tied to JPM EMBI Global USD. The fund holds 60% government bond securities and 40% corporate bond securities. This is a “High Yield” bond fund. Keep in mind another name for high yield is “junk bond.” This hold true as the average credit quality of the bonds in this fund is B. For your reference a B rating is described as being “highly speculative”. The fund has a high expense ratio relative to its peer group.
If you have any other Emerging Markets Investments that you think should be added to the list post them in the comments below.