Tim Hanson has a stark warning for ETF investors, one that flies in the face of conventional wisdom; emerging market ETFs are “a pretty package with some very scary contents.” Hanson, senior portfolio analyst with Motley Fool Asset Management, has a new report out with a very direct title, “Ditch These ETFs Now.”
“The genesis of the report was that Fool members and investors were coming to us and saying, ‘we want exposure to emerging markets,’” Hanson tells AdvisorOne. “The knee-jerk reaction is to use an ETF, but before we make that type of a recommendation, we take a hard look at the space. What we found was a significant disconnect between what people thought they were getting versus what they actually got.”
For instance, some investors asked about the iShares/FTSE Xinhua 25 Index ETF (NYSE: FXI), the most popular ETF currently available. What they didn’t realize is that is has a 40% to 50% exposure to Chinese banks.
“They were shocked when we told them, to say the least,” Hanson says.
In addition to the iShares/FTSE Xinhua 25 Index ETF, Hanson names two other ETFs to “ditch now.”
iShares MSCI Brazil (NYSE: EWZ)
According to Hanson, while this ETF will get investors access to Brazil abundance of commodities, it virtually ignores the Brazilian consumer as well as the Brazilian mobile phone and Internet user.
“The reason is that the companies winning in Brazil in these industries simply aren’t headquartered in Brazil,” he writes. “Brazil’s top mobile phone companies are headquartered in Spain and Mexico, for example, and its number one e-commerce platform in Argentina. Should your emerging markets portfolio suffer because a successful company chose to incorporate in one country instead of another? Of course not.”
iShares MSCI Emerging Markets Index (NYSE: EEM)
This is the most popular emerging markets fund in the world, Hanson notes, with almost $30 billion of assets under management.
“Yet even with all of its resources, it too suffers from the same flaws as the two other ETFs,” he concludes. “More than 20% of its assets are stashed in financial stocks, including the major Chinese banks, and another 25% are in the giant commodity companies that are feeding demand in the developed world more so than anywhere else.”
His bottom line?
“Index investing is an important tool for every investor … I believe, however, that indexes are approaching the emerging markets in entirely the wrong way, looking backward instead of forward and applying the flawed belief that the larger a company is, the larger a position it deserves in your portfolio,” he said. “Emerging markets, however, are growing too quickly for that to make sense, which is why you should consider alternatives when it comes to your long-term investing strategy.”