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Russia Boosts Emerging Market ETFs

NEW YORK (TheStreet) --Just because a fund is called an Eastern Europe ETF, doesn't mean it's an Eastern Europe ETF.

Last week, Hungary shook the region when politicians made negative comments about the country's debt situation. Investors looking to broad Eastern European ETFs may be looking in the wrong place if they wanted to see the impact and play a rebound.

Emerging market funds have performed poorly this year. For instance, global emerging market funds such as iShares MSCI Emerging Markets Index (EEM) and Vanguard Emerging Markets (VWO) have underperformed the S&P 500 in the past three months.

During the same time period, SPDR S&P Emerging Europe (GUR) and iShares MSCI Emerging Markets Eastern Europe (ESR) underperformed even VWO and EEM.

In the past few weeks though, the situation has begun to turn around. In the trailing one month period, VWO and EEM now are outperforming the S&P 500, and both ESR and GUR are outperforming VWO and EEM.

However, the composition of these ETFs shows why they outperformed, and the big flashing sign for ESR and GUR is Russia. As of March 31, ESR had 74% of assets in Russian stocks, while GUR reports 66% of assets in Russia as of June 4.

In the past three months, the resource heavy iShares MSCI Brazil (EWZ) and Market Vectors Russia (RSX) underperformed India and China ETFs, while in the past month, Russia and China have led the group (Brazil remains the underperformer). We see GUR and ESR outperform emerging markets when Russia leads and underperform when Russia lags.

However, the situation in Eastern Europe has become serious enough to dent returns, as both GUR and ESR were underperformers on Friday.

Broadly speaking, emerging market funds decline when investors want to cut back on risk. They are seen as riskier investments and even though the sovereign debt crisis stems from developed Europe, the implications are global because it is causing the U.S. dollar to rally.

These sorts of pullbacks are not necessarily a vote of no confidence on the fundamentals and potential for growth in emerging markets though, as investors are rapidly fleeing on fear, not a well thought-out investment idea.

Stock quotes in this article: EEM, VWO, GUR 

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