Emerging-Market ETFs: The Good and the Bad

I have never been a fan of iShares MSCI EAFE Index Fund(EFA Quote) as a way to create foreign exposure. The attributes of the underlying countries get blended away, which reduces a meaningful portion of the benefit of foreign investing.

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:

MSCI Israel Capped Investable Market Index(EIS Quote)

MSCI Thailand Investable Market Index(THD Quote)

MSCI Turkey Investable Market Index(TUR Quote)

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) 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) and iShares MSCI Brazil(EWZ Quote).