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Emerging-Market ETFs: The Good and the Bad

Roger Nusbaum

For people inclined to use ETFs for their foreign allocation, I think single-country or regional funds are a much better way to go.

iShares has dominated this space in the ETF world and recently listed three new single-country funds:

The funds merely provide proxies for their respective markets. Each one has pluses and minuses in their composition.

In making a decision about whether any of the funds is the best tool for you to capture those countries (assuming that an investor wants any of the three), they must each be dissected, and the weightings must be factored into the rest of the portfolio.

Israel

Israel's economy has a lot going for it -- it has good GDP growth and is a hotbed of high-tech innovation.

It would be natural to think an Israel ETF would be a great way to capture that dynamism, but a quick peek under the hood shows that 24% of the fund is in Teva Pharmaceuticals(TEVA Quote - Cramer on TEVA - Stock Picks) and another 21% is in the financial sector. Technology accounts for only 12.47% of the fund.

The back test of the index has been very good, 27% annualized for five years, as Israel's stock market has done very well.

Teva is no slouch -- I own it for clients -- but EIS has a lot of exposure to the one stock, and any problem for Teva will hurt the fund. Someone allocating a 5% weight to EIS needs to account for the 1.25% that the Teva position in EIS adds to their overall health care allocation.

Thailand

Thailand is well known for its occasional political flare-ups and currency problems. But lately, growth has been solid, the currency has been strong and the stock market has done well; the back test for THD has a 33% annualized return for five years.

The fund has some quirks, however, which make me cautious.

The largest sector is energy at 37% of the fund. It is curious that so much of the index is in energy, because Thailand is a net importer of both oil and gas. The energy sector, more so than most of the others, seems to be vulnerable to political risk. Again, this is a country that has had plenty of political issues in the past.

The second-largest sector is the financials, at 30% of the fund. If the current problems in the U.S. ever domino to Southeast Asia, this fund seems like a good bet to get the flu.

The extra risk taken in Thailand has not resulted in a better return than simply buying a broad-based emerging-market fund. I would note that some country ETFs do beat broad emerging-market funds, such as iShares MSCI Chile(ECH Quote - Cramer on ECH - Stock Picks) and iShares MSCI Brazil(EWZ Quote - Cramer on EWZ - Stock Picks).

Turkey

Turkey has a lot going for it. It has a large population with an average age around 20 years old. It recently opened an oil pipeline from Azerbaijan, for which it collects a toll. It is working to join the European Monetary Authority, which may or may not happen, but it looms as a positive catalyst. At the same time, interest rates are high, inflation is always a struggle, and the stock market has a history of being wildly volatile.

TUR is 53% in financials. The market in Turkey is down more than 30% since mid-October (when the S&P 500 peaked). The fund's heavy weight in financials actually makes it a little easier to assess.

The interest-rate structure in Turkey and the heavy weighting in financials tell you it is a complex market that has a real chance of sustaining more damage if there are more shoes to drop with the U.S. banks, or if those U.S. shoes kick any of the European banks.

The long-term story for Turkey is quite promising, and that should translate into very positive results in the stock market when the turn does come. While buying into a country you like after a 30% correction is not the worst thing you can do, it seems as though the market could be in for more downside for a few more months.

What to Do

Of the three, I am most favorably disposed to EIS for its more immediate growth prospects and what seems to be less exposure to the global financial problems.

The reason I generally prefer narrow funds over broad-based funds is that you can seek out attributes of specific countries you think offer the best potential result, along with better diversification.

Blending together a high-yielding deficit country, like Turkey, with a lower-yielding surplus country like Norway, or maybe a combination of a commodity-based country and service-based economy, allows for more precise impact on the portfolio.

This approach is not right for everyone, but I think that people who take the time to seek out articles on a site like TheStreet.com are probably more inclined to do the requisite study.