February 4, 2011

Emerging-Asia Equity ETFs: Investing in Global-Growth Leaders

Several exchange-traded funds focus on the newly industrialized Asian economies.

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With every passing day, the outsized economic growth that Asia’s emerging economies are currently experiencing makes them harder and harder for investors to ignore.

Some of the fastest-growing countries in the world are in Asia. China, India, and the “newly industrialized Asian economies”Hong Kong, Singapore, Taiwan, and South Korea,– led the world in economic growth in 2010, according to International Monetary Authority data.

China, India, and the ASEAN nations – Vietnam, the Philippines, Indonesia, Malaysia, and Thailand – will lead global economic growth in 2011 and 2012, according to IMF projections.

Growth in China has been so strong it is starting to stoke inflation, leading Chinese monetary authorities to raise interest rates. That has served to cool investment demand for Chinese stocks recently, pushing the benchmark Shanghai Composite Index to a four-month low in late January.

Stronger growth in emerging Asian economies has been a part of the global economic landscape for quite some time, yet there are surprisingly few exchange traded funds (ETFs) that offer investors an easy way to gain exposure to the region.

There are several Asia/Pacific ETFs, but these ETFs tend to be dominated by large-cap Japanese and Australian companies, most of which do business globally and therefore do not make a good proxy for emerging Asian growth.  

For specific exposure to emerging Asia, one option is the iShares S&P Asia 50 fund, which garners a marketweight ranking from S&P’s proprietary ETF ranking methodology, which incorporates not only an analysis of past performance but also the likely future prospects of the underlying holdings, as well as costs and risks.

The ETF invests in the 50 largest companies listed in four Asian markets: Hong Kong, Singapore, South Korea, and Taiwan.

While these markets are making a transition from emerging to developed economies, they offer exposure to China through the Hong Kong listed companies, and they stand to benefit from the growth in emerging Asia due to their proximity.

The fund’s largest country allocation as of February 1 was South Korea, which accounted for 28% of assets, followed by China (24%), and Taiwan (22%).

Its performance has been strong, gaining 28.2% in the 12 months ending February 1, 2011, above its peer average.

Its top three holdings were S&P buy-ranked Samsung Electronics, accounting for 11.6% of assets, followed by S&P buy-ranked Taiwan Semiconductor (6%) and S&P buy-ranked China Construction Bank (5.5%). The ETF has about $230 million in assets, and its yield at year-end 2010 was about 2%.

Another option is the State Street SPDR S&P Emerging Asia ETF, though S&P ranks it as underweight due to its gross expense ratio (higher than the iShares ETF), low scores from a technical perspective, and ownership of securities that rank low in S&P’s proprietary Fair Value Model.

(This model calculates a stock's weekly Fair Value – the price at which it should trade at current market levels – based on fundamental data such as corporate earnings and growth potential, price-to-book value, return on equity, and current yield relative to the S&P 500.)

For instance, one of the ETF’s top holdings is Infosys, which garners a Fair Value ranking of only 2. In the Fair Value system, stocks are ranked from 5, indicating significant undervaluation, to 1, indicating significant overvaluation.

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