Many investors I talk to want to increase their exposure to emerging markets abroad. However, they don't feel qualified to analyze individual companies' stocks beyond the United States. Instead, they take advantage of the recent growth in country-oriented exchange-traded funds (ETFs) to buy a single diversified position in a country that they believe has meaningful long-term growth potential. Unfortunately, this seemingly elegant approach can be more dangerous than they suspect.
Many country-oriented ETFs don't necessarily give investors the exposure they're looking for. These ETFs are generally tied to market cap-weighted indexes, which tilt exposure toward big companies in long-developed industries. These relative titans may not share the same growth potential of the underlying emerging market they call home.
Six dangerous examples
Consider these popular emerging markets, and the ETFs that are ostensibly good proxies for investing in them:
Country |
ETF |
Top Sectors |
---|---|---|
Brazil |
iShares MSCI Brazil Index |
Materials (26.2%), Financials (25.1%), Energy (20.6%) |
Chile |
iShares Chile Index Fund |
Utilities (25.2%), Industrials (20.4%), Materials (19.3%) |
China |
iShares FTSE Xinhua 25 Index |
Financials (47.7%), Telecom (18.0%), Oil & Gas (11.9%) |
India |
PowerShares India |
Energy (25.3%), Information Technology (16.4%), Financials (13.0%) |
Indonesia |
MSCI Indonesia Investable Market |
Financials (28.2%, Consumer Discretionary (13.7%), Consumer Staples (12.5%) |
Mexico |
iShares MSCI Mexico |
Telecom (30.7%), Consumer Staples (24.1%), Materials (15.8%) |
Source: iShares and PowerShares.
As you can see, when you buy one of these funds, you may not be getting the exposure you're hoping for. This is perhaps most glaring in China, where buying into the iShares FTSE Xinhua 25 Index will net you a whopping near-50% position in state-run Chinese banks, and just 2% exposure to the Chinese consumer.
Chinese banks were recently asked to stress test for a 50% to 60% decline in housing prices; many of them have spent the summer looking for new capital. Chinese consumers, on the other hand, are sitting on virtually no debt and $2 trillion in spending power. Which sector would you rather have exposure to?
A Mexican company that's not all that Mexican
Then there's iShares MSCI Mexico, which stashes a whopping 27% of its assets in America Movil
Similarly, it's a little bit shocking that iShares MSCI Brazil offers just 2% exposure to Brazil's profitable telecommunications industry. In part, that's because the fund can't hold shares of Mexico's America Movil. In addition, Brazil's index is heavily dominated by banking and commodity heavyweights. Yet these are the two most developed parts of Brazil's economy, and they don't share the same growth prospects as more consumer-oriented companies such as Redecard, Natura Cosmeticos, and MercadoLibre
Finally, the PowerShares India fund's No. 1 holding, with more than 10% of assets, is Infosys
Be careful what you buy
Although ETFs offer diversification and convenience, too many country ETFs aren't constructed to provide good solutions for intelligently increasing your emerging-markets exposure. Instead, your best bet is careful stock selection or a low-cost, actively-managed fund. There's simply no excuse for inadvertently ending up overweight on Chinese banks.
Get Tim Hanson's Global View column every Thursday on Fool.com, or by following him on Twitter.