Is it time for investors to bail big time on what Donald Rumsfeld called "Old Europe?"
With the right combination of funds, it's possible to build a portfolio that sidesteps most of Western Europe. In the process, you'll gain valuable pieces of the emerging stock and bond markets and small companies in the U.S.
Given the steady stream of bad news, it doesn't look like there will be major relief any time soon from the debt migraines from Greece, Italy, Spain and Portugal. The contagion now has spread to push borrowing costs higher for France and Spain (see link.reuters.com/jas25s for the latest news).
To sidestep the problems, or diversify your portfolio away from the chaos, you can build an "Anything But Europe" investment strategy. Here are some suggestions for that approach:
-- THINK EMERGING MARKETS
Developing countries that fit into this definition have tangential connections to Europe and are still growing. They should be a staple of your portfolio anyway because of the global opportunities they present. A good all-around vehicle is the iShares MSCI Emerging Markets ETF. Although it concentrates more than half of its portfolio in just four countries -- China, Brazil, South Korea and Taiwan -- it's a good way to sample developing countries.
-- THE BRIC STRATEGY
Investing in just Brazil, Russia, India and China has always seemed like more of a gimmick to me than a widespread attempt to diversify in a greater array of emerging markets. Yet, if you want to make a focused bet on these goliaths, this is the way to go. The iShares MSCI BRIC Index Fund is one approach, although it invests about two-thirds of its holdings in China and Brazil. China and Brazil, both targeted to grow in coming years, have a symbiotic relationship. Both will do well under a steady-growth scenario. China needs Brazil's agriculture output and other resources for its increasing population. The South American country is relying upon China as a key export market for commodities such as soybeans.
--EMERGING MARKETS DEBT
Since the European bond market is mostly in turmoil over sovereign debt, you can avoid most of the fray by investing in emerging-market bonds. The PowerShares Emerging Markets Sovereign Debt Portfolio invests in bonds from countries like Indonesia, Colombia, Qatar and Turkey.
-- U.S. SMALL COMPANIES
While they are especially sensitive to economic conditions, small-cap companies may be good holdings to have long term since bigger, multinational companies tend to have larger European exposure. A broad-basket index fund such as the Vanguard Small-Cap ETF is worth considering.
I make no claim as to how any of these funds will perform if the European contagion triggers a global recession; few countries are immune to downturns outside of their borders. No matter where they are based, companies are still dependent upon growing earnings and the economies of the countries in which they operate. Bonds are still sensitive to interest rates, which, if they rise, will depress prices. And smaller countries tend to have more volatile stock and bond markets.
Many of the funds I've recommended have declined in value this year, so I'm definitely thinking long-term and only recommend them for investors with a horizon of several decades. None of my picks are free from risk and will be volatile as the Europeans -- and Americans -- sort out their debt dilemmas.
It's not that I don't believe Europe will figure out how to avoid a U.S.-style meltdown like in 2008. They may bring back ancient currencies like the drachma or lira. Or, France and Germany may just lead the way to craft a reformed euro zone. And the European Central Bank might play a larger role.
There's no harm in being cautious, though. A debacle is still possible. If you're pessimistic and regard the euro zone as a dangerous play, you should stay away from the major players. Long-term, I think Europeans will sort things out. Collectively they still comprise the largest single developed market in the world. If you include the former Eastern bloc countries and Russia, you have a colossus that can't be ignored.
The author is a Reuters columnist. The opinions expressed are his own.
(Editing by Jilian Mincer and Beth Gladstone)