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International Investing
Conquering Emerging Markets
By William Brennan & Michael Byman
Bill-Principal, Michael-Director, Capital Management Group, LLC
Russia. India. China. Brazil. With their booming economies and stock market returns reminiscent of the late ’90’s, emerging markets have enormous appeal. The proliferation of single-country Exchange Traded Funds makes it easy to inexpensively buy into entire national markets, or even sub-sectors of markets, in one fell swoop.
How to decide if, and where, to establish positions?
First, make sure you don’t stray from your overall asset allocation plan. Most diversified investors should have between 10% and 20% of their assets in international markets, and only a portion of that should go to the riskier emerging markets. Even though returns may be tempting, these economies come with all sorts of risks: Immature industries and financial markets; a limited number of industry sectors and companies; and a variety of socio-economic and political factors. You want to participate in the long-term growth of these economies while minimizing the negative impact of the periodic, extreme downturns characteristic of volatile markets.
Second, consider national economies and political environments. Cheap labor, educated populations, abundant natural resources, growing consumer spending and other factors are important but not sufficient. Sustained growth will depend on long-term economic stability and policies that enable businesses to thrive. Because of the difficulty in predicting which countries will manage this process best over the long haul, it makes sense to invest in several different emerging markets.
Third, look at available funds: Review not only fees and valuations, but also the number and diversity of securities held. Broad emerging markets funds invest in numerous countries, but frequently have big positions in just a few. Single- country funds may buy an entire national market or just several sectors. Some countries have truly “emerging” markets – which have a low correlation with developed markets like the US, Western Europe and Japan – while other countries have more mature markets that won’t give you as much diversification. Choose funds that complement each other and the rest of your portfolio, not funds that have significant overlap in holdings.
We like to fine-tune our clients’ portfolios with a combination of broad and single-country emerging markets funds. For example, we might start with the broad iShares Emerging Markets fund (EEM). With expenses of 0.77% annually, this fund gives cheap exposure to a wide swath of emerging markets. But about half of the fund’s portfolio is in just four countries: South Korea (18%), South Africa (12%), Taiwan (11.3%) and Brazil (10%). So we supplement it with various single country funds where we want more representation, such as India and China.
Don’t make the mistake of placing an outsized share of your portfolio in emerging markets in the hope of a re-run of 2005’s outsized returns. But do make wise use of the growing array of investment choices in this area to achieve more targeted diversification of your international holdings.
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