By John Wasik
CHICAGO, Feb. 10 Since the beginning of the
year, emerging markets have been like cats on a hot tin roof.
Hot money is skittering out of foreign markets as countries
from Argentina to Turkey have been clawed by economic and
political turmoil. But even with heightened concerns about the
prospects of developing countries, emerging markets should still
be a part of your larger portfolio.
A combination of currency crises and the "taper" of the
Federal Reserve's bond-buying program - possibly resulting in
economic slowdowns - have triggered the exodus in emerging
markets. More than $12 billion left emerging markets stock funds
in January alone, according to EPFR Global, with bond funds in
this sector losing nearly $3 billion last week alone.
While nearly every emerging markets fund has been nicked
this year, some funds have been clobbered. The WisdomTree Brazil
Real ETF lost 90 percent of its assets between Jan. 28
A common strategy is to invest in countries that are not
part of this rout. That means pulling money out of countries
like Argentina, Brazil, Indonesia, Turkey and South Africa and
moving into countries whose currencies are more stable. While
that's easy for institutional investors or those holding
country-specific exchange-traded funds (ETFs), it's awfully
difficult for individual investors.
One consideration is to find a wider base of smaller,
"frontier" countries that are not being impacted by the currency
woes or the Fed's moves.
The iShares MSCI Frontier 100 ETF, for example, has
81 percent of its portfolio in Africa and the Middle East, with
only 13 percent in Asian emerging markets and 4 percent in Latin
America. It's up 1.4 percent year to date through Feb. 7 and
gained almost 24 percent last year. It charges 0.79 percent in
HOW TO VIEW THE VOLATILITY
If you want to isolate trouble spots, you'll have to prune
your portfolio to avoid trouble ahead.
The "Fragile Five" - India, Indonesia, Brazil, Turkey and
South Africa - are vulnerable because of a plethora of economic
and political problems. According to Neena Mishra, director of
ETF Research for Zacks Investments in Chicago, you may need to
do some incisive sorting.
Mishra says the most troubled countries have high current
account deficits to GDP and short-term external debt to foreign
exchange reserves ratios - "that is, countries that are
dependent on foreign capital and are thus vulnerable to the
But not all emerging markets are alike. Some have healthy
economic outlooks and are worth holding. Mishra likes countries
prone to "solid macroeconomic fundamentals, pegged currencies
(to the U.S. dollar) and low correlations to developed markets."
This group would include the Gulf states, Mexico, South Korea,
Taiwan and Vietnam.
While it's tempting to cherry pick developing countries, is
it practical to strip out the most troubled countries from your
portfolio? Probably not, which means a general emerging market
index fund might be too volatile right now - if that's a
A global fund that invests in both developed and emerging
markets might fit the bill. The Vanguard Total World Stock Index
ETF, invests in a mix of mostly large companies with only
about 8 percent of its portfolio in developing countries in
Africa, Asia and Latin America.
Although it's down 3 percent year to date through Feb. 7,
the Vanguard fund gained 23 percent last year and costs 0.19
percent in annual expenses. It holds well-known companies that
have a global presence such as Apple Inc, Nestle SA
and HSBC Holdings.
Another way of dealing with the uncertainty of emerging
markets is to embrace it as the cost of doing business as a
long-term investor. Don't bulk up in any one country or region
and invest across every continent - if you can afford to take
the risk now.
What you will not be able to do with any global or emerging
markets fund is to avoid ramped-up volatility this year. To
dampen that concern, reduce your foreign exposure to no more
than 20 percent of your portfolio or simply stomach the risk and
hold for the long term.