Have ETF, Will Travel: Emerging Markets a Natural For Global Investing

By Brian O’Connell

Exchange traded funds (ETF’s) are big business – no doubt about that.

According to a recent study by Black Rock International, at the end of February 2011, the global ETF industry had 2,557 ETFs with 5,802 listings and assets of $1.3 trillion (in U.S. dollars) from 140 providers on 48 exchanges around the world. A year earlier, the ETF market included 2,091 ETFs with 3,998 listings and assets of $1 trillion from 115 providers on 40 exchanges.

The popularity of ETFs isn’t exactly a mystery. Investors like them because they can use ETFs to mirror favorite indexes without the surprises, in both risk management and fees, of traditional mutual funds that attempt to cover the same turf. For example, the average expense ratio for U.S.-listed ETFs is about 0.4%, compared with 1.42% for diversified U.S. stock funds, according to the investment research firm Morningstar.

It’s the same story in Europe, where the average expense ratio on actively run mutual funds in Europe is 1.75 percent, but only 0.37 percent for Europe-based ETFs, Morningstar http://www.morningstar.co.uk/uk/news/article.aspx?lang=en-GB&articleid=87483&categoryid=415 adds.

As Morningstar notes, “When confronted with two investment options–one sporting an annual expense ratio of 1.5% and the other 0.25%–the only guarantee is that you will pay an additional 1.25 percentage points to invest in the former.”

That’s an important point for U.S. investors not just in Europe, but in foreign bourses across the worlds. Emerging market ETFs are increasingly becoming the investment vehicle of choice for such investors; who want the leverage and diversity that emerging markets offer, but without the hefty management fees that actively-managed funds offer.

Why Emerging Market ETFs?

It’s no secret that as increasingly global-minded investors become more savvy about mutual fund expenses and how they are managed, more of them are willing, if not eager, to give emerging market ETFs a closer look at the expense of mutual funds. With overseas ETFs, proponents say, it’s investors who make money – not their broker or fund manager.

Why emerging market ETFs? Why not? If you want to go overseas but don’t want to try and pick the three hottest stocks on, say, the Nikkei Index, use an ETF fund instead. For instance, the iShares MSCI Japan Index, which tracks the Nikkei 225 index, offers a significantly lower risk than going the individual stock-picking route or trying to find a reasonably-priced fund manager who’s trying to do the same thing.

Emerging market ETFs are especially a viable option give current U.S. economic conditions. There is no shortage of reasons to suggest that pouring all of your investable assets into American stocks is a short-sighted move these days.

The primary reasons to go overseas include:

— A weaker U.S. dollar

— A natural resources boom with high global demand

— The continuing emergence of India and China and other emerging market economies.

Plus, investor sentiment is coming into play. With the US economy perched on the precipice, thanks to the flailing real estate market and a lousy jobs market, US investors are turning overseas to reduce volatility in their portfolios, essentially “recession-proofing” their holdings.

None of those issues – all beneficial to emerging market investors – – are going away anytime soon.

How to Get Into Emerging Market ETFs

Now that we know the “why” – what about the “how”. Actually, investing in emerging market ETFs doesn’t require much heavy lifting.

But it does require some advance planning. Here are some of the most important steps you can take to fully leverage the ETF-based emerging markets.

Bundle up – For the beginning ETF investor, focusing vertically on just one ETF in only one country may represent too high risk a move. Yes, the Argentina ETF (Stock Quote: ARGT) is up 844% so far in 2011. But neighbors Peru and Chile are down for the year. It’s much better to bundle your country risk together and invest in a regional ETF like Emerging Latin America (Stock Quote: GML) and spread your risk around. It’s the same idea for sector analysis. You can, for example invest in oil or gold ETFS that offer access to those commodities in multiple countries.

Kicks some tires – Emerging market ETFs are a foreign concept  – literally – to most U.S. investors. So you want to know where your money is going before you make any commitments. One good way to research emerging market ETFs is to check out the risk exposure of each investment vehicle. For example, regional or country-specific ETFs may be more heavily weighted in industries you may consider too risky. Market Vectors Russia carries a heavy energy weighting – that could be a problem in a developing economy with looser regulations and substandard technology – factors that could make energy play in Russia more volatile.

Don’t forego bonds – With the U. S. dollar down, an emerging market ETF can act as a good hedge against the buck. Emerging Market Government Bonds (Stock Quote: EMB) offers a great way to get that hedge against U.S interest rates. You can also leverage foreign currency ETFs, which enables you to further hedge interest rate risk or engage in an exchange rate investment strategy. There are plenty of foreign currency ETFs to choose from, but the Euro (Stock Quote: FXE) and the Swiss Franc ETF (Stock Quote: FXF) are two of the top performing emerging market ETFs in the global marketplace.

BRIC isn’t everything – The natural tendency for most first-time emerging market investors is to take the conventional approach and invest in the four BRIC economies (Brazil, Russia, India and China (Stock Quote: BIK) that most money managers like to recommend. No doubt, the BRIC play does offer access to some of the world’s fastest-growing economies – but it could be at the expense of even better emerging market ETFs. Consider the Indonesia ETF (Stock Quote: IDX). The country is one of the most rapidly growing economies in the world, with one of the lowest labor costs, and highest rates of investment. Then there’s the South Korea ETF (Stock Quote: EWY), which is rolling along at an 8.1% clip so far in 2011, thanks in large part to a humming manufacturing base. The point here? Don’t always take the road most-traveled with emerging market ETFs – save some money for smaller, nimbler country ETFs, too.

Top of the List

If the end game in investing is to lower one’s risk exposure, diversify assets, but still gain access to some of the top-performing countries and industries in the world, emerging market ETFs are at the top of the list of investments that fit the bill on all three fronts.

Just do your homework first, and don’t rely too much on one country or one sector. Past that, know that by making emerging market ETFs a part of your portfolio, you’ve strengthened your financial future by taking your investments overseas.

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