Last year, emerging-market ETFs couldn’t beat bond or utility funds with a stick. But this year is shaping up to be radically different. In an improving economy, safe, stodgy investments are decidedly out of fashion as investors are willing to bear more risk to maximize returns. That means that now is a great time to reconsider the right emerging-market funds.
Bears bet big on a sluggish economy in 2011 and were rewarded for their caution. Exchange-traded funds (ETFs) that held Treasuries or investment-grade debt hammered junk bond or emerging-market funds, and investors who bought into strategies to short the long bond last year took it on the chin.
For example, PIMCO 25+ Year Zero Coupon Treasury (NYSE:ZROZ) and Vanguard Extended Duration Treasury (NYSE:EDV) returned more than 60% last year, while ETFs such as ProShares UltraShort Lehman 20+ Year Treasury ETF (NYSE:TBT), which bets against long Treasuries, dropped nearly 50% in 2011.
Dividends were the key to utility ETF performance last year, with the Utilities Select Sector SPDR’s (NYSE:XLU) nearly 4% yield sweetening the pot for investors. XLU ended the year up 15%, well ahead of ETFs in most other sectors.
But clinging to last year’s investment strategy is as ill-advised as showing up at Fashion Week in last year’s frock — and far more dangerous. So far this year, bears are returning to hibernation and bulls are setting their sights on summer in Pamplona. Consider this: ZROZ and EDV are already down nearly 8% and 7% respectively this year; XLU is down 2.6%.
By contrast, emerging-market ETFs are attracting a lot of attention — and cash — in 2012, as InvestorPlace’s Jim Woods noted on Feb. 9.
Are there still risks that could clobber emerging-market funds in 2012? Absolutely, but as with all investment strategies, it’s about balancing the potential rewards with a comfortable level of risk. One other note: emerging-market ETFs often have higher expense ratios than ETFs in other sectors — long government ETFs average 0.16, and utility ETFs average 0.49.
That said, here are four hot emerging-market ETFs that look good so far in 2012:
EGShares Emerging Markets Metals & Mining (NYSE:EMT) could have a comeback year in 2012. EMT boasts among its top holdings Brazilian mining company Vale SA (NYSE:VALE), Russian nickel and palladium producer MMC Norilsk Nickel (OTC:NILSY) and coal-mining stock China Shenhua Energy (PINK:CUAEF).
With last year’s sluggish economy and slowdown in China, this ETF struggled, but its fortunes are set to improve this year if the raw-materials market rebounds — particularly since it’s value priced now, in the $17.50 range. It has a market cap of just under $15 million and a dividend yield of about 3.4%. The expense ratio is higher than I typically like at 0.85, but year-to-date return is a very nice 21%.
PowerShares Global Emerging Markets Infrastructure (NYSE:PXR) is a slightly different play in emerging-market infrastructure growth, including heavy-equipment giant Caterpillar (NYSE:CAT), Swedish robotics and automation tech company ABB Group (NYSE:ABB) and China’s Anhui Conch Cement Co. (PINK:AHCHF).
Whereas EMT focuses on the raw materials of infrastructure development in emerging-market countries, PXR focuses on the companies that enable the work. After posting strong gains every year since its 2008 inception, the ETF fell 14% last year and is trading around $45 today. It seems to have recovered its footing in 2012: it’s up more than 20% so far this year. With a market cap of nearly $130 million, PXR has a higher-than-optimal expense ratio of 0.75 but a dividend yield of 1.5%.
ProShares Ultra MSCI Emerging Markets (NYSE:EET) is a leveraged ETF, so it’s very different from the funds above. While those funds hold the securities of the companies that comprise the index they track, this leveraged ETF aims to provide a return that is double that of the index — in this case, the MSCI Emerging Markets Index. EET accomplishes this through credit default swaps and other derivatives and equities. Last year, EET fell more than 17%. There is no dividend, but the return is eye-popping: So far in 2012, EET has gained more than 32%. With a market cap of $29.6 million, EET is trading around $84.50 and has an expense ratio of 0.95.
WisdomTree Emerging Markets Equity Income (NYSE:DEM) is a good way to play emerging markets such as Brazil and China — and the dividends are nice, too. This ETF holds a basket of emerging-market stocks with attractive dividends, including Taiwan Semiconductor (NYSE:TSM), Bank of China (OTC:BACHY), Brazilian beverage giant AmBev (NYSE:ABV) and South African mining company Kumba Iron Ore Ltd. (PINK:KIROY). Unlike most of its peers in emerging-market ETFs, DEM returned nearly 4% last year; so far in 2012, it’s up more than 12%. With a market cap of $3.2 billion, DEM is trading around $58 and has the lowest expense ratio in our little group, at 0.63. Its current dividend yield is nearly 4%.
As of this writing, Susan J. Aluise did not hold a position in any of the investments named here.