Emerging Markets ETFs: You Can’t Run From Economic Turmoil

With the world’s more developed countries delivering a constant barrage of negative news, investment ideas that seek profits from emerging countries are becoming an increasingly popular outlet.

The iShares MSCI Emerging Markets Eastern Europe ETF (NYSE:ESR) began Sept. 30, 2009. This ETF is based on the MSCI Emerging Markets Eastern Europe Index, which is energy-heavy. The resulting breakdown by industry is energy (46.37%), banks (18.51%), materials (15.5%), utilities (7.43%), telecommunication (5.78%), insurance (1.76%), food & staples retail (1.59%), S-T securities (0.98%), pharmaceuticals (0.7%), real estate (0.48%) and other (0.83%).

About half the holdings are tethered to the energy sector, and the returns of ESR reflect this imbalance:

• 1 month: -5.07%
• 3 months: -19.51%
• YTD: -14.94%
• 1 year: 0.48%

Another participant in this sector is the Market Vectors Egypt Index ETF (NYSE:EGPT). Van Eck is the sponsor of this ETF and is promoting this as a tax-efficient way to gain exposure to Africa�s third-largest economy. The inception date for EGPT is Feb. 16, 2010.

The top 10 holdings are Orascom Construction Industries (8.37%), Commercial Intl COMI EY (7.46%), Orascom Telecom Holdings (6.78%), Telecom Egypt (6.55%), Egyptian Kuwaiti Holdings (6.01%), Talaat Moustafa Group (5.46%), Efg-Hermes (5.08%), Centamin Egypt (4.82%), Egyptian Co for Mobile Svcs (4.56%) and Transglobe Energy (4.48%).

The weighting to industries is financials (42.1%), telecommunications (17.1%), materials (13.8%), industrials (12.4%), energy (7.6%), consumer staples (4.5%), consumer discretionary (2.4%) and other (0.1%). This interesting mix, with top-heavy exposure to financials, has delivered the following returns.

• 1 month: -3.2%
• 3 months: -23.06%
• YTD: -38.53%
• 1 year: -32.34%

Because ETFs can be sold short, this might make a good candidate for such a strategy.

Lastly, another strategy that is based on a similar theme is the PowerShares MENA Frontier Countries ETF (NYSE:PMNA). PMNA offers a diversified approach by investing in companies that are located in the Middle East and North Africa regions. The inception date is July 9, 2008. The allocation by country is Kuwait (20.65%), Qatar (20.11%), Egypt (18.62%), United Arab Emirates (17.76%), Jordan (8.06%), Morocco (7.7%), Bahrain (4.12%), Oman (2.8%) and other (0.18%).

The spreading of risk among this group has produced the following returns pattern:

• 1 month: 0.63%
• 3 months: -8.65%
• YTD: -17.11%
• 1 year: -12.49%
• 3 years: -13.98%

Clearly the diversification between the countries assisted in buffering the negative returns. PMNA might be another candidate for a short selling strategy.

Based on this small sample, seeking profits in emerging country ETFs will be challenging. Even though numerous media sources discuss how these economies are growing, the underlying common element is that companies in these economies tend to do business with countries in well-developed countries. The result is an �importation� of developed-economy problems.

Jeffrey L. Stouffer is the principal of Mercantile Capital Group, a Herndon, Va.-based introducing broker registered with the CFTC and a member of the National Futures Association. He can be reached at mercapitalgroup@aol.com. Stouffer does not own any direct or indirect holdings in any of these ETFs.