Emerging market exchange-traded funds (ETFs) are not securities that excite a lot of investors. Some of that is because the term “emerging markets” sounds a little scary, and some of it is because our own market has been doing so well. Yet emerging market securities are an essential part of your portfolio, because they are not directly correlated to the U.S. market.
Why is that important?
As I discuss in the strategy outline for my stock advisory newsletter, The Liberty Portfolio, it is essential to reduce risk in a portfolio by investing in non-correlated assets. You don’t want every security to move up and down in tandem with the U.S. market.
Emerging market ETFs are about 77% correlated to the U.S. market, on average. Even that is much much higher than it used to be (it used to be about 20%).
Here are some emerging market ETFs to consider for your portfolio. However, you have to stay on top of these investments, because while they are not heavily correlated to the U.S. market, much of the success of the emerging market ETFs depend on local GDP growth.
Emerging Market ETFs: First Trust Chindia ETF (FNI)
Both China and India are seeing GDP growth in the mid-6% range, almost the highest in the world. Consequently, you could concentrate your strategy to these regions with the First Trust Chindia ETF (NYSEARCA:FNI). To be included, a security must be in India or China, be on the NYSE or NASDAQ, have a $250 million market cap minimum, and have at least a million dollars of trading volume per day. Then FNI takes the top 25 stocks from each country based on a liquidity score.
Unsurprisingly, IT accounts for 40% of the assets, with consumer discretionary at 26%, financials at 16%, and all others less than 5% each. The FNI was issued in 2007, and it is about double the price it was back then. It has exploded this past year, and was up almost 60% to $43, until this last correction took it down to $39.34.
This is a volatile, concentrated position. Be careful with it.
Emerging Market ETFs: iShares MSCI Brazil Capped ETF (EWZ)
Brazil’s last economic report showed a mediocre GDP growth rate of 1.4% in September. However, that is expected to pick up and hit 3.3% by year-end. The iShares MSCI Brazil Capped ETF (NYSEARCA:EWZ) is only 65% correlated to the U.S. market, so it is also worth looking at.
EWZ is aimed at large and mid-sized companies in Brazil, with 55 holdings, and contains all the major companies domiciled there. Certainly Ambev SA (ADR) (NYSE:ABEV) is the most familiar name, owner of major beer and drink brands like Budweiser. Beck, Corona, Pilsen, Modelo and Skol.
The average price-to-earnings ratio for stocks in EWZ is not outrageous, at 17.4, despite the EWZ gaining 20% last year. Again, be careful because of the single-country allocation.
Emerging Market ETFs: Powershares S&P Emerging Markets ETFs (EELV)
If you’d like to be more conservative, consider the PowerShares S&P Emerging Markets Low Volatility Portfolio (NYSEARCA:EELV). The goal of this ETF is take securities which were the least volatile over the previous 12 months out of the companies in the S&P Emerging Plus Large MidCap Index — all publicly listed stocks with market values of at least $100 million and trade at leaset $50 million in shares annually from Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Malaysia, Mexico, Morocco, Peru, Qatar, the Philippines, Poland, Russia, South Africa, South Korea, Taiwan, Thailand, Turkey and the UAE.
The idea is to stick with lower-volatility stocks, which means less risk to the index. It’s not the best choice out of emerging market ETFs, but it’s kind of the least bad. The problem is that most of the ETFs in the emerging market sectors aren’t actively managed, so they can’t go in and just select top notch companies and build a portfolio.
For that, you may want to look at mutual funds, such as the Morningstar five-star rated American Funds New World Fund Class C (MUTF:NEWCX).
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any stock mentioned. He has 23 years’ experience in the stock market, and has written more than 2,000 articles on investing. Lawrence Meyers can be reached at [email protected].