Expand beyond developed countries

WITH growth in advanced economies forecast to be sclerotic for the near future, investors should look to capitalise on the more dynamic prospects of emerging markets (EM). The International Monetary Fund is forecasting that developed economies will shrink overall by 3.12 per cent this year versus developing economies’ growth of 6.14 per cent.

One of the simplest ways to benefit from EM growth is to invest in a regional or country-based ETF. You should be sure to evaluate how the ETF gains its exposure – whether it is through tracking various national indices or manually choosing equities. Nizam Hamid at iShares reports that the past 12 months have seen significant asset flows into EM country-based ETFs, the most popular being India at €500m, followed by Brazil at €400m and Russia at €380m. The advantage of basing your investment on countries is that you get exposure to the full range of growth, from infrastructure to raw materials to service industries.

Country-based ETFs do, however, carry the normal risks associated with equities. Another way of targeting EM growth is instead to look at currency-based products. Just this week, ETF Securities launched exchange-traded currencies that track the renminbi. With the yuan unpegged (though still carefully managed) and China likely to see significant medium-term growth, its currency is ripe for long-term appreciation. ETF Securities’ Nicholas Brooks says: “It would be something one would invest in and put aside on the assumption that it will be a good proxy for the high growth one will see in China versus some Western countries.”

But if forex ETCs also seem too risky or insubstantial, try looking at commodities. Hamid highlights that while 12 months ago, 85 per cent of commodity ETF asset flows involved gold, these days precious metals account for less than half of flows, with 30 per cent now involving diversified commodity and agriculture funds.

The global downturn has seen commodity prices plummet since 2008 (see chart) because global trade was arranged around developed-country demand and emerging market exports. But Brigitte Posch of Pimco thinks that in response, there will be a greater effort to stimulate domestic EM consumption: “Leaders of emerging nations now realise their economies are vulnerable if they remain largely dependent on export demand. They learned this lesson from the difficulties of their best ‘customers’ – the developed nations. This is why we expect emerging nations to facilitate domestic demand over the next three to five years.”

Basic commodities like industrial metals will be key both to facilitating this demand through infrastructure (schools and roads) and to supplying it. Most investors looking for exposure to commodities opt for broad thematic ETFs: Brooks reports asset inflows to ETF Securities’ base metals basket of $325m in the last year and of $382m into their agricultural equivalent.

Investors in certain commodity-based ETFs, however, should be wary that they are not missing out on significant extra returns when prices shoot up. You won’t get direct access to spot prices through ETFs, meaning that if demand suddenly takes off in a particular area, you will gain less than you might otherwise have done. If this is a concern, consider an ETF that tracks futures that are a few months ahead, which should significantly alleviate the problem.

Overall, don’t expect smooth and immediate returns from EM investment: it is very hard to time macroeconomic growth precisely. Growth will take political reform and time so you are best off making your investment and sitting back to let it grow.