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Emerging markets frequently promise better returns than their domestic counterparts.
Still, they come with a special set of (manageable) risks that we don't always find at home.
A profound reaction to the Fed's tapering, higher-than-comfortable inflation, current account deficits, and outright political instability have all made for a volatile 2014 in the emerging markets.
It's easy to see why. Investors are worried about how they'll be impacted by the tapering of the Federal Reserve's bond purchases. And now Brazil, India, Indonesia, Turkey, Russia, and South Africa are now experiencing inflation of 6% to 7%.
Those same countries are facing current account deficits of between 4% and 7%, which places downward pressure on their currencies and upward pressure on inflation and interest rates.
And political volatility in Russia, Ukraine, Turkey, and elsewhere are contributing to uncertainty that's reflected in market performance.
But the truth is, for investors who know what they're holding, these emerging markets still hold outsize profit potential.
And taking your share of this growth has never been easier, thanks to these special securities...
A Tale of Two Funds
Here's a look at two of the largest emerging markets exchange-traded funds (ETFs), and how the same sector can offer widely varied risk exposure.
The easiest way for investors to gain broad emerging markets exposure is through two large emerging market ETFs that dominate the landscape:
- iShares MSCI Emerging Markets Indx ETF (NYSE Arca: EEM); and
- Vanguard FTSE Emerging Market ETF (NYSE Arca: VWO).
The MSCI fund is roughly $40 billion in size, while the Vanguard is about $30 billion in size.
There are dozens of other emerging markets ETFs, but the next largest in size is only $3 billion.
These two ETFs have some similarities - they both have significant holdings in Chinese equities, for instance. But each offer investors very different exposures in terms of both companies and countries.
And, importantly, each offers investors a chance to own a significant chunk of the ultra-high growth happening in these markets.
Global Growth Play No. 1
iShares MSCI Emerging Markets Index
The Emerging Markets Index holds Tencent Holdings Ltd., Taiwan Semiconductor Manufacturing (NYSE: TSM), China Mobile Ltd. (NYSE: CHL), and China Construction Bank Corp. (HKG: 0939) among their top six holdings.
But EEM's largest exposure is to South Korea.
This is because Samsung Electronics is the fund's single biggest exposure, representing almost 4% of its total investments.
Interestingly, Samsung does not show up among VWO's top 10 holdings.
When considering Ukraine impact, EEM holds roughly 1% of their assets in Russia's energy interests.
EEM is investing more of its assets in Brazil, with positions in:
Itau Unibanco Holding SA (BVMF: ITUB4);
Companhia de Bebidas das Americas-AmBev (BVMF: AMBV3);
Banco Bradesco SA (BVMF: BBDC4); and
Petroleo Brasileiro Petrobras SA (BVMF: PETR4)
These companies are among the Emerging Market Index fund's 20 largest holdings.
Global Growth Play No. 2
Vanguard FTSE Emerging Market ETF
Vanguard also includes the same top six companies as the Emerging Markets Index. But, rather than South Korea, China is Vanguard FTSE's largest country exposure at about 17.5%.
The ETF has low exposure to Russian investments, with a much heavier focus on Asia.
The 21st Century's Biggest Opportunities
Investors seek out emerging markets because they offer higher growth prospects than developed markets.
The problems that have emerged in these markets in early 2014 come from huge inflows of capital - the result of central banks printing enormous amounts of money to rescue the global financial market from the 2008 financial crisis.
Unfortunately, much of this capital was not invested productively, leaving a legacy of high inflation and high capital account deficits.
But don't be dissuaded; these markets are home to important global companies that are still growing at impressive rates, beating the S&P 500 many times over.
An examination of iShares MSCI Emerging Markets Index and Vanguard FTSE Emerging Market ETF's holdings makes it clear that their managers are focused on Asian technology and media companies that, like their Western cousins, are capable of growing rapidly regardless of the issues facing their home markets.
These ETFs should continue to offer investors diversified plays on long-term Asian growth as well as an added benefit of technology and media-related growth from some of the most exciting companies in the world in the years ahead.
As we've seen in emerging markets, volatility isn't necessarily something to be feared. It can walk hand-in-hand with fast, robust growth. Even better, there's a way for investors to profit immensely from volatility spikes. Learn More...
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About the Author
Prominent money manager. Has built top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.