U.S. Investors poured a stunning $54 billion into
emerging-market exchange-tradedfunds (
) in 2012, according to research firm ETFGI. That's a stunning
growth from just $3 billion in 2011. The two largest ETFs in the
Vanguard FTSEEmerging Markets ETF (NYSE:
iShares MSCI Emerging MarketsIndex (NYSE:
now have a hefty $125 billion in assets under management.
Many investors have moved beyond those catch-all funds, and are
now focusing on country-specific ETFs such as the
iShares FTSE China 25Index Fund (NYSE:
iShares MSCI Brazil Index (NYSE:
. But many still don't know about the two most important factors
thatwill affect their returns.
I'm talking aboutcurrency andinflation .
The Nikkei's blunted rally
While Washington was mired in year-end talks over the "Fiscal
Cliff," Japanese investors were breaking out the champagne. A new
government in Tokyo, promising to provide a major stimulative boost
to theeconomy , kicked off a majorstock rally.
But U.S. investors who had the foresight to invest in Japan
aren't quite so happy. Since the start of November 2012, the
Japanese yen has weakened, from 79 yen to the dollar to a recent
89.3. The yen's 13%depreciation has offset some of the Japanese
stockmarket 's gains, meaning U.S. investors have failed to fully
prosper from the rally.
However, it works both ways. A number of economists say the
rally in the yen has come too quickly, aided by short-covering by
investors who were betting against the dollar. These economists say
the yen will restrengthen in coming weeks, which means that an ETF
such as the
MAXIS Nikkei 225 Index (NYSE:
will likely get a lift from the currency reversal. The key takeaway
is to steer clear of any country-specific ETFs if you think the
country's currency is too strong and due for a drop. (Indeed, the
Japanese yen had been trading near all-time highs against the
dollar until the recent pullback).
The inflation bug
Japan's economy is quite advanced, and onpar with our own. As a
result, inflationary concerns are nearly non-existent at the
moment, as is the case in Europe and the United States. But in more
dynamic emerging economies, inflation is an ever-present
Nearly two years ago, I extolled the
virtues of Vietnam
and recommended the
Vietnam Fund (NYSE:
as a solidinvestment choice.
Soon thereafter, the Vietnamese economy started to choke on its
own growth, as bottleneck pressures led to rising inflation. Here's
the problem with inflation: It forces government to take a series
of punitive measures to slow the economy to help reduce
inflationary pressures. Vietnamese inflation figures are now
starting to trend lower, which helps explain why the Vietnamese ETF
has begun to rally.
Back in 2011, I looked at
India as well
, noting that :"years of steady growth -- 14.4% annually in the
past decade -- have created choke-points in the economy where the
roads, bridges and rail lines simply can't keep up with the rising
level of economic activity."
Fast forward to 2013, an India finally appears to have inflation
under better control. As
TheWall Street Journal
, India's inflation rate has slowed to its lowest level in three
years. A slowing economy gets some of the credit, as do several
keyinvestments in infrastructure in major cities that have removed
The drop in inflation is expected to lead to government policies
that augment economic growth (whereas the Indian government had
sought to slow the economy while inflation was rising). As a
result, the Indian economy looks set to rebound in 2013 and 2014,
making for a more timely entry point for thisfund .
Risks to Consider:
Investors are pouring into emerging-market funds, but they will
need to have a strong stomach. These funds can quickly lose steam
if the U.S. market stumbles, which is why you need a multi-year
time horizon with your emerging market investments.
Action to Take -->
Whenever you are assessing emerging markets, you must spend time
analyzing the country's currency and inflation pressures. An
already-weak currency and a benign inflation backdrop, are two key
positives you want to look for.
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.
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