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By John Wasik
CHICAGO, Feb. 10 (Reuters) - Since the beginning of theyear, emerging markets have been like cats on a hot tin roof.
Hot money is skittering out of foreign markets as countriesfrom Argentina to Turkey have been clawed by economic andpolitical turmoil. But even with heightened concerns about theprospects of developing countries, emerging markets should stillbe a part of your larger portfolio.
A combination of currency crises and the "taper" of theFederal Reserve's bond-buying program - possibly resulting ineconomic slowdowns - have triggered the exodus in emergingmarkets. More than $12 billion left emerging markets stock fundsin January alone, according to EPFR Global, with bond funds inthis sector losing nearly $3 billion last week alone.
While nearly every emerging markets fund has been nickedthis year, some funds have been clobbered. The WisdomTree BrazilReal ETF lost 90 percent of its assets between Jan. 28and 29.
A common strategy is to invest in countries that are notpart of this rout. That means pulling money out of countrieslike Argentina, Brazil, Indonesia, Turkey and South Africa andmoving into countries whose currencies are more stable. Whilethat's easy for institutional investors or those holdingcountry-specific exchange-traded funds (ETFs), it's awfullydifficult for individual investors.
One consideration is to find a wider base of smaller,"frontier" countries that are not being impacted by the currencywoes or the Fed's moves.
The iShares MSCI Frontier 100 ETF, for example, has81 percent of its portfolio in Africa and the Middle East, withonly 13 percent in Asian emerging markets and 4 percent in LatinAmerica. It's up 1.4 percent year to date through Feb. 7 andgained almost 24 percent last year. It charges 0.79 percent inannual expenses.
HOW TO VIEW THE VOLATILITY
If you want to isolate trouble spots, you'll have to pruneyour portfolio to avoid trouble ahead.
The "Fragile Five" - India, Indonesia, Brazil, Turkey andSouth Africa - are vulnerable because of a plethora of economicand political problems. According to Neena Mishra, director ofETF Research for Zacks Investments in Chicago, you may need todo some incisive sorting.
Mishra says the most troubled countries have high currentaccount deficits to GDP and short-term external debt to foreignexchange reserves ratios - "that is, countries that aredependent on foreign capital and are thus vulnerable to theFed's taper."
But not all emerging markets are alike. Some have healthyeconomic outlooks and are worth holding. Mishra likes countriesprone to "solid macroeconomic fundamentals, pegged currencies(to the U.S. dollar) and low correlations to developed markets."This group would include the Gulf states, Mexico, South Korea,Taiwan and Vietnam.
While it's tempting to cherry pick developing countries, isit practical to strip out the most troubled countries from yourportfolio? Probably not, which means a general emerging marketindex fund might be too volatile right now - if that's ashort-term concern.
A global fund that invests in both developed and emergingmarkets might fit the bill. The Vanguard Total World Stock IndexETF, invests in a mix of mostly large companies with onlyabout 8 percent of its portfolio in developing countries inAfrica, Asia and Latin America.
Although it's down 3 percent year to date through Feb. 7,the Vanguard fund gained 23 percent last year and costs 0.19percent in annual expenses. It holds well-known companies thathave a global presence such as Apple Inc, Nestle SA and HSBC Holdings.
Another way of dealing with the uncertainty of emergingmarkets is to embrace it as the cost of doing business as along-term investor. Don't bulk up in any one country or regionand invest across every continent - if you can afford to takethe risk now.
What you will not be able to do with any global or emergingmarkets fund is to avoid ramped-up volatility this year. Todampen that concern, reduce your foreign exposure to no morethan 20 percent of your portfolio or simply stomach the risk andhold for the long term.
