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December 28, 2010

The Smart Way into Emerging Markets

Even though emerging markets have been hot performers over the past year, typical mutual fund investors haven’t been getting their fair share of that sizzling performance.

That’s because according to Standard & Poor’s 2010 Scorecard of active funds versus indexes, a decisive 85.94 percent of all actively managed emerging market mutual funds have been handedly beaten by the S&P/IFCI Composite, a benchmark of emerging market stocks. Here’s the translation: If investors would’ve just bought an index fund or index ETF they would’ve done better!

Let’s evaluate four strategies for investing in emerging markets.

Broadly Diversified

An investment like the Vanguard Emerging Markets ETF (VWO) is one of the easiest ways to invest in fast growing economies around the world. VWO offers market exposure to mega developing countries like Brazil, China and Russia. The fund also charges annual fees of just 0.27 percent.

The main advantage of a broadly diversified emerging market ETF is it generally avoids single country or regional blowups that sometimes occur.

Regional Plays

Instead of trying to guess which individual countries within a certain region are going to outperform their peers, investing in the entire geographic area might make sense.

State Street Global Advisors has regional ETFs that follow emerging countries in Europe (GUR), Latin America (GML), Middle East and Africa (GAF) and Asia Pacific (GMF). All of the funds charge 0.60 percent annually.

Individual Countries

People willing to risk their money on the performance of stocks within a certain country have plenty of ETF choices.

For example, BlackRock through its iShares unit now offers 40 single country ETFs and 19 dedicated to emerging countries. The largest of these is the iShares MSCI Brazil Index Fund (EWZ) which has produced head turning returns of 18.85 percent over the past ten years.

Many single country emerging markets ETFs actually double as industry sector bets since they tend to be concentrated in commodities, energy or other top sectors of their respective country.

Certain fund providers like Van Eck Global offer exposure to Russia (RSX), Indonesia (IDX) and Poland (PLND). Most individual country ETFs will have expense ratios between 0.50 percent and 0.90 percent.

Leverage and Shorting

One final way to capitalize on emerging markets is by using funds or ETFs that attempt to magnify their performance (leverage) or funds that increase in value when emerging markets decline (short).

For example, an advisor that wants to make super bullish short term trade with the potential for magnified gains in emerging market stocks but without using a margin account should consider the DirexionShares Daily Emerging Markets Bull 3x Shares (EDC), DirexionShares Daily Latin America Bull 3x Shares (LBJ) or the DirexionShares Daily India Bull 3x Shares (INDL).

Advisors with a bearish view should look at the opposite trades of those mentioned above; the DirexionShares Daily Emerging Markets Bear 3x Shares (EDZ), DirexionShares Daily Latin America Bear 3x Shares (LHB) and DirexionShares Daily India Bear 3x Shares (INDZ). As the names for all of these funds indicate, they aim for daily leveraged returns and for that reason are best used as short-term plays.

Conclusion

Even though emerging markets offer the potential for high returns, the average annual expenses for mutual funds following this category are a very steep 1.76 percent according to Morningstar data. In contrast, the median expense ratio for emerging markets ETFs is just 0.65 percent.

In summary, successful investing for your clients in emerging markets means more than just choosing the right vehicle. It also means minimizing fees.

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