Emerging-Markets Large-Caps Take on Dow

NEW YORK ( TheStreet) -- As the Dow and S&P 500 slumped last decade, emerging markets boomed.

Now as we start a new decade, iShares has started selling two emerging-market sector exchange traded funds, the iShares MSCI Emerging Market Financial Sector Index Fund ( EMFN) and the iShares MSCI Emerging Market Materials Sector Index Fund ( EMMT). It's a way to buy into those industries' growth as Brazil, China and other developing countries rise in wealth and stature.

That said, the iShares ETFs are similar to those recently issued by EG Shares, the EG Shares Dow Jones Emerging Markets Financials Titans Index ( EFN) and the EG Shares Dow Jones Emerging Markets Metals & Mining Titans Index Fund ( EMT).

Despite tracking different indexes, the ETFs own the same mega-cap or blue-chip names. Both are heavy in Brazil and China, and, in the case of the two materials funds, South Africa. The big difference is that the MSCI methodology underlying iShares also takes in South Korea, with the financial fund having a 10% exposure and the materials fund 12%.

The two financial funds have six of their top 10s in common, including Itau Unibanco Holding ( ITUB) from Brazil and China Life Insurance ( LFC). The materials funds also overlap with names like Vale ( VALE) from Brazil, Impala Platinum Holdings ( IMPUY) from South Africa and Norilsk Nickel ( NILSY) from Russia.

The iShares ETF, by virtue of being able to own South Korea, allocates 6.5% to Posco ( PKX), the mega-cap steel producer. One quirk in the iShares funds, reflected in the iShares MSCI Brazil Index Fund ( EWZ), is that it owns both the common and the preferred issues of Vale, which accounts for 18% of the fund. The preferred stock is just as volatile as the common, so a misstep by the company would hurt the iShares fund far more than the EG Shares fund.

The iShares funds are a direct attack on the inroads EG Shares has tried to make on the ETF industry. In addition to the similarities of fund construction, they only charge 0.72% in management fees versus 0.85% for the EG Shares. Even the ticker symbols of the funds are almost identical.

For now, there is little interest in any of the funds. The EG Shares average less than 10,000 shares per day traded, the iShares MSCI Emerging Market Materials Sector Index Fund has only averaged 1,200 shares a day, while the iShares MSCI Emerging Market Financial Sector Index Fund didn't trade one share in its first week on the market. The lack of interest in this space is corroborated by WisdomTree's recent decision to close seven of 10 foreign sector funds. Those included developed- and emerging-market stocks.

The lack of interest, for now at least, is unfortunate because the past decade has shown the importance of country and sector selection. As the S&P 500 dropped 24%, investors willing to invest in specific countries added tremendous value to their portfolios. iShares MSCI Brazil, hardly an obscure investment destination, was up 250%. In that same period, iShares MSCI Hong Kong ( EWH) rose 20%. At the industry level, the Financial Select Sector SPDR ( XLF) was down 40% for the decade, far worse than the broader stock market, while the Technology Select Sector SPDR ( XLK) plummeted 60%.

While some say it's impossible to correctly pick sectors and countries, the market gives the occasional warning about what to avoid, especially at the sector level. Occasionally a sector grows to be too large relative to the S&P 500, often because of some sort of investment mania. In the early 1980s, during the first alternative-energy boom, that sector grew to be 30% of the S&P 500, only to implode. Ten years ago, technology grew to 30% during Internet-stock mania. A few years ago, the financial sector swelled to 22% of the index before crashing in what we're calling the worst financial crisis in 80 years.

Regardless of the fundamentals, real or perceived, anytime a sector grows larger than 20% of the S&P 500, it should be underweighted. This will spare a lot of pain. Building a portfolio with sector funds allows for these types of decisions to be implemented by anyone uncomfortable with picking individual stocks.

Similarly, it doesn't take much to assess a country's debt situation, unemployment level and other macro-economic factors. Recently, Pimco's Bill Gross talked about avoiding countries like the U.K., France and Japan for possibly having unsustainable debt. It's also easy to see that Denmark and Australia have very little debt to reckon with.

None of this guarantees any success, but avoiding the parts of the market that pose the most risk puts the odds in your favor. This is most easily accomplished by using specialized funds like the iShares MSCI Emerging Market Financial Sector Index Fund and the iShares MSCI Emerging Market Materials Sector Index Fund.
At the time of publication, VALE was a client holding.

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.

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