New ETF Seeks Yield in Exotic Places

Pairing Up

If you are inclined to use a broad-based product, such as DEM, for emerging-market exposure, it makes sense to pair it with something a little narrower. In exploring how to do this, I would pick a spot that DEM does not cover, and there are several.

DEM has less than 0.50% each in Russia and India. Both countries, while clearly not for the timid, offer a compelling long-term theme for growth, modernization and the chance to become more important in the world economic order.

Another gap could be in the financial sector. Most emerging-market countries have a big publicly traded bank that is often heavily weighted in the local index and serves as a good proxy for that country.

Emerging markets have roughly 7%-8% of the global market capitalization, implying 7%-8% as being a portfolio equal-weight. A reasonable pairing might be 5%-6% in a broad-based fund such as DEM, and 2% in a country fund or individual stock that DEM, or any other fund, might be missing. This gives a chance to benefit from a good theme selection without rolling the dice on just one outcome.

A last point to make is that emerging markets are up a lot over the last few years and are expensive relative to where they have traded historically. DEM's P/E ratio is 15, in line with the other funds.

Historically, this asset class has traded in the high single digits as a means of compensating for the extra risk taken. The higher P/E belies the great performance, but higher P/Es can also be viewed as the market believing these areas are less risky than they once were -- that is, that they have matured.

This will be true to a degree, but I don't believe the argument that they are cheap stands up, and for the time, being an equal-weight position might be the best way to go.

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At the time of publication, Nusbaum and his clients were long BLDRs Emerging-Market ADR 50, although positions may change at any time.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback; click here to send him an email.