Political unrest is something almost all nations have to deal with from time to time, whether it takes the form of peaceful town hall meetings or violent uprisings and demonstrations. This time around, Egypt has taken center stage as millions of citizens take to the streets to demand the end of the nation's current regime. As the protests stretch on, investors are understandably asking how Egypt's political problems affect their portfolios.
Risky business
One potential area of risk is to U.S. financial institutions that have made loans to Egypt. But according to IMF data, of the approximately $49 billion in outstanding loans to the Egyptian government, only $5.4 billion is from U.S. banks. That's not enough to really create big problems for any U.S. multinationals. And while Citigroup (NYSE: C) and other financial institutions with truly global reach may be more at risk than many of their competitors, they still don't have enough exposure for Egypt to be a big threat.
Mutual funds or exchange-traded funds that invest directly in Egyptian companies may also face elevated risks in the coming weeks. Just a year ago, fund provider Van Eck launched the Market Vectors Egypt Index ETF (NYSE: EGPT). Van Eck was forced to suspend creation orders for new shares of the fund when the Egyptian stock market was shut down at the end of January. As a result, the fund has been building up cash because it cannot issue new shares. It could take some time before the ETF can get back to business, deploy its cash reserves, and accurately track its intended market.
Small potatoes
But for investors who own more diversified mutual funds, most may not even be sure if their portfolio has any direct exposure to Egypt. Well, the bottom line is that if you have a diversified portfolio, yes, you probably do have some direct exposure to the nation. But it's likely not enough to worry about in any way.
According to Morningstar data, the two most popular emerging markets exchange-traded funds, iShares MSCI Emerging Markets ETF (NYSE: EEM) and Vanguard Emerging Markets Stock ETF (NYSE: VWO) have a mere 0.4% allocation to Egypt. That's not nearly enough to get upset about or to have a meaningful impact on your portfolio even if events take a turn for the worse.
Of course, there's more potential for exposure in actively managed mutual funds if a manager decides to overweigh the Egyptian market. However, even in such cases, you're probably still not talking about a lot of assets devoted to this area. For example, Templeton Frontier Markets (TFMAX) is a relatively new fund that invests primarily in "frontier markets," which include the smallest tier of the developing nations such as Bangladesh and Vietnam as well as smaller emerging market nations such as Egypt. Even in a fund like this, exposure to Egyptian companies only amounts to 4.7% of total fund assets. Of course, other funds will vary, but even if you're a big emerging markets investor, it's unlikely that you've got significant exposure to Egypt lurking in your portfolio.
Casting a wide net
So while you shouldn't even be thinking about hitting the panic button as a result of the unrest in Egypt, recent events do highlight one of the big risks involved in emerging market investing: political risk. Developing nations are much more prone to this type of disruption and also face greater odds of periodic economic stability. Volatility will remain high in this sector, and investors would do well to keep in mind that emerging markets are likely due to take a breather at some point.
At any rate, it might be wise to lower near-term expectations. At current valuations, emerging markets aren't likely to keep putting up the kind of high-flying returns they have in recent years. That doesn't mean they're not a good long-term buy, but you may have to weather some downturns along the way.
And as the Market Vectors Egypt Fund's troubles highlight, single country funds and ETFs are generally more risky than worthwhile for most investors. Stay away from funds that invest in just one country, unless you are an admitted speculator. While Egypt is small enough on the world stage to avoid making huge fiscal waves, just imagine the fallout around the globe, not to mention the potential risk involved in a China-focused fund like Market Vectors China ETF (NYSE: PEK) if China's economy were to take a sudden slide.
When investing in emerging markets, make sure you stick to well-diversified funds that invest across a range of countries and regions. Exchange-traded funds like the iShares or Vanguard emerging markets funds mentioned above are a good choice. If you prefer active management in this arena, think about picking up a low-cost fund with an experienced manager such as T. Rowe Price Emerging Markets Stock (PRMSX).
While all eyes will remain on Egypt for some time, investors would do well to keep a level head about the situation as it relates to their investments. Time will tell how the protests and demonstrations will end, but we shouldn't fear for our pocketbooks in the meantime.
For more winning mutual fund recommendations and time-tested personal financial planning advice, check out the Fool's Rule Your Retirement service. You can start your free 30-day trial today.
