PXR: PowerShares Bets on Continued Emerging Market Infrastructure Development

On October 16, PowerShares debuted its Emerging Markets Infrastructure Portfolio Fund (PXR) amidst one of the most difficult periods for emerging markets in the last decade. While U.S. markets have declined significantly due to the recent financial crisis, emerging markets have been hit even harder by the global crisis. PXR’s debut, however, may not be as ill-timed as some investors believe. As emerging economies rallied on October 13 and 14, the recovery served as a reminder of the incredible potential of small economies worldwide—a potential that PXR proposes to capture.

PXR tracks the S-Network Emerging Infrastructure Builders Index. This index is designed to mirror the overall performance of the stocks of companies involved in the infrastructure construction in and overall development of emerging market economies. A variety of industries are included in this definition, and PXR will include construction and engineering, construction machinery, construction materials, diversified metals and mining, heavy electrical equipment, industrial machinery, and steel. PXR’s index provider may include other industries in the index as appropriate.

As emerging economies grow, the infrastructure, or grid, on which they are built expands to meet the needs of the population. The rapid expansion in many parts of the world in the last decade has created a tremendous need for infrastructure as countries develop the physical structures that support a society. Such structures include roadways, railroads, pipelines, power grids, seaports and communication systems vital for day-to-day life.

Bruce Bond, president and CEO of Invesco PowerShares, believes that infrastructure will remain a key factor in the global marketplace:

“Emerging market countries building infrastructure necessary to sustain their economic growth have created enormous worldwide demand.” Bond believes that the structure of PXR will lend itself easily to the content of the fund, noting that “we believe the PowerShares Emerging Markets Infrastructure Portfolio (PXR) will provide investors a precise way to capture a global group of companies responsible for construction and development of emerging market infrastructure using the benefit-rich ETF structure.”

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Recent gains in GDP have allowed emerging market countries to meet the growing demand for infrastructure development. The recent commodities boom allowed for growth in developing markets, and emerging economies have been able to earmark a greater percentage of funding for infrastructure improvements. In an April 2008 study, Morgan Stanley predicted that a total of $21.7 trillion would be spent on infrastructure spending over the next decade. China, PXR’s largest component, has spent an estimated 9% of GDP on infrastructure over the past few years.

The MSCI Emerging Markets Index (EEM) climbed 6.5% on October 14, after rising 7.4% October 13. The combined gain marked the largest increase in the index since it was conceived two decades ago. Russia—PXR’s second-largest country allocation led these gains, advancing as much as 16%. These gains come after a week of record declines, where the index fell 20%.

Ronald Smith, chief strategist for Alfa Bank in Moscow, seems optimistic about the prospect of a rally: “After the massive declines of the past few months, a very large relief rally in percentage terms is possible, if not inevitable.” Smith believes that the recent market downturn and volatility could continue in the future, however, as “investor sentiment in developed markets is likely to decline again as markets grapple with the inflation and currency implications of...coordinated interventions.”

Despite recent setbacks in emerging economies, PXR’s launch comes on the heels of a decade of incredible emerging market growth. Many emerging economies, spurred by a commodity boom and a decline in the U.S. dollar, have accumulated large levels of foreign exchange reserves. The current global decline in asset values has caused many of these governments to tap into their reserves to bolster their currencies and markets. As global aid and intervention alleviate the pressure on emerging markets, PXR’s investors could reap rewards on the upswing.

While investment in an emerging markets fund—like PXR—can garner exceptional returns in positive global markets, the downside risk is also greater than average. Emerging markets can be extremely volatile, and investment in them can expose a portfolio to a variety of market and political risks. Commodity and currency issues have worn down emerging markets in recent weeks, dragging some international equities to bargain levels. For those investors willing to wade back in to emerging markets, PXR presents a “back to basics” approach that could rebound quickly.

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