Japan, Argentina on Sale for the Brave

08/09/2010 12:11 pm EST


Carlton Delfeld

Editor, The La Jolla Letter and Pacific Gains

Political crises often produce great investing opportunities, writes Carlton Delfeld in Around the World with ChartwellETF.com.

[In assembling a global ETF portfolio,] know what drives specific markets. Chile is dependent on copper prices, Austria is a banking play on Eastern Europe, Russia is highly focused on oil and natural gas and South Korea is increasingly integrated into China’s economy.

Keep in mind that the quality of the countries you choose to invest is critical, but overreaching when valuations are high is hazardous. Oftentimes the best time to buy into a country's stock market is when it is beaten down, but there are signs that its economic and political problems will sharply improve. These value situations also limit your downside risk. I have [had] a sizable core holding in Indonesia for some time, am building positions in Argentina, and [am] considering Japan as a good contrarian play.

Many otherwise astute investors fail to recognize the importance of politics in global investing. Political change cuts both ways and can present great investment opportunities. Most great bull markets begin with significant economic reform. In emerging markets, regulatory and political risk can swamp traditional portfolio analysis. Who can dispute that India’s election last spring ignited a tremendous rally or the that the clear and commanding reelection of President Yudhoyono—better known as SBY in Indonesia—contributed mightily to the 100% plus surge of its market in 2009. Recently, the election of pro-market leaders in Chile and Colombia reassured investors and boosted their respective markets.

[One should also] minimize company risk. Instead of trying to pick the best three stocks on the Tokyo Stock Exchange, why not just minimize company risk by buying the iShares MSCI Japan ETF (NYSEArca: EWJ) that tracks the Nikkei 225 and spread this risk amongst 225 Japanese companies? Or you could hedge your bets and do both. Japan has lagged but if the Japanese yen weakens in 2010 (as I suspect) the EWJ and the [double] inverse Japanese yen ETF, ProShares UltraShort Yen (NYSEArca: YCS) will soar.

Be careful to look under the hood of ETFs to see where your money is going. For example, let‘s look at the iShares MSCI Emerging Markets ETF (NYSEArca: EEM). It invests in 23 different countries, so it is natural to think that you will get broad exposure to all countries. You would be wrong: 50% of your investment in this fund is going to four countries: South Korea, Brazil, Taiwan, and China, while only about 2% [goes] to Indonesia, Malaysia, and Turkey. In addition, incredibly, 4.9% is going to one company, Samsung Electronics of South Korea.

The same is true for the MSCI Europe, Asia and Far East (EAFE) index. It contains 21 developed countries, but 38% of the money you invest would go to just two: Japan and the United Kingdom. Meanwhile, less than 3% would go to Singapore and Ireland. Country-specific ETFs such as the iShares FTSE/Xinhua China 25 Index ETF (NYSEArca: FXI) can also have a fair amount of concentrated risk. Although the FXI tracks a basket of 25 companies, the five largest account for nearly 50% of your exposure.

The same problem applies to the MSCI World index, where only 12% of your investment is going to emerging markets, even though they represent 35% of global GDP, 83% of world population, about 30% of global consumer spending, and more than 50% of global economic growth.

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