Despite Hiccups, Emerging Market ETFs Still Have Appeal

Emerging markets ETFs have taken a step back this week, down about 2% so far. But that doesn't mean the rally is over. On the contrary, there's new evidence to support the idea that emerging markets have a role in any portfolio and investors who ignore them do so at their own peril.

• Economic Freedom. The Index of Economic Freedom saw a major shift recently: the United States saw its position decline to eighth place, bested primarily by Asian economies. Hong Kong took the top spot, followed by Singapore, Australia and New Zealand. Economic freedom measures how free citizens of a particular country are to work, produce, consume and invest how they please. The United States’ ranking dropped as a result of government intervention and a rapidly rising deficit.

• Global GDP. Emerging markets account for 50% of global gross domestic product, and counting. In fact, between 2008 and 2025, developing economies are projected to account for more and more of global GDP, according to research by PricewaterhouseCoopers.
• The Great Frontier. Frontier market stocks, as tracked by MSCI, have gained about 21% in the last year. The MSCI Emerging Markets measure, meanwhile, has more than doubled. Although there is extra risk tied to these economies, the rewards can be greater. [We've heard about the BRICs, now the MAVINS?]
• Better Productivity. The Conference Board compared productivity trends across 111 countries and found growth in output per worker in developing economies while developed country productivity wanes. The measure of worker productivity called “total factor productivity (TFP),” which works out productivity improvements that come from firms investing in new technology or hiring better-educated workers is what emerging markets are gaining on. In emerging economies, TFP rose at an annual rate of 2.4% from 2005 to 2008, compared to 0.2% in advanced economies.
• Curbing Your Enthusiasm. China’sgovernment took a few steps to keep things in check in its rapidly growing economy. One such move is raising the minimum reserve requirement put in place by its banks, guiding credit to sidestep inflation and asset bubbles. Brazil also recently instituted a tax on foreign investment in order to mitigate the risk of a bubble, as well.
• Big Auto Markets. Indian car sales rose the most in three years in 2009 as economic growth and cheaper loan rates helped the country withstand a global slump in demand. December sales in the country surged 40%. The recovery within India’s economy as others falter has automakers focusing on this market, as the size of India’s market is now a palatable size. New car sales in Brazil had their third straight record year in 2009; China is the world's largest auto market, and expanded its lead over the United States in November 2009.

Among the many ETFs to consider:

• Vanguard Emerging Markets ETF (NYSEArca: VWO)
• iShares MSCI Emerging Markets (NYSEArca: EEM)
• EGS Dow Jones Emerging Markets Titans Composite (NYSEArca: EEG)
• SPDR S&P Emerging Markets (NYSEArca: GMM)

For full disclosure, Tom Lydon's clients own shares of VWO and EEM.

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