Forbes’s Fundamental Opportunity Index is based on the idea of value investing: buying underpriced, fundamentally sound stocks. Many people believe that emerging markets, which were up more than 70% in 2009, are likely to pull back, or at least take a breather in 2010. Nonetheless, there are still opportunities in those markets.
The most popular ETF to provide emerging markets diversification is iShares MSCI Emerging Markets Index Fund (NYSEARCA:EEM), which provides investment results that correspond to publicly traded securities in emerging markets.
GDP vs. Market Cap
EEM weights countries based on their market capitalization rather than GDP. The following chart shows its top 10 countries breakdown:
click to enlarge
As you can see from the BRIC countries GDP chart below, China accounts for 7.1% of world GDP, much higher than Brazil’s 2.6%. However, its share in EEM is smaller than Brazil's.
Top 5 Countries within EEM
Country ETFs are another great way to find undervalued opportunities. Following are the top 5 countries and their ETFs within EEM:
Over the past decade China has spent massively on roads, bridges, ports and other infrastructure. Even though China's infrastructure is already superior to that of many other developing economies, it still continues to expand: now it focuses on high speed railroads and subways.
While the U.S. struggles with the effects of heavy stimulus spending and bailouts, investors could benefit from a weakening dollar by boosting their exposure to foreign currency. Followings are emerging market currency ETFs:
CurrencyShares Mexican Peso Trust
CurrencyShares Russian Ruble Trust
WisdomTree Dreyfus Brazilian Real
WisdomTree Dreyfus Chinese Yuan
WisdomTree Dreyfus Emerging Currency
WisdomTree Dreyfus Indian Rupee
WisdomTree Dreyfus South African Rand
Top 15 Holdings inside EEM
Followings are EEM’s top 15 stocks (by % of assets) traded on US exchanges:
% Net Assets
PETROLEO BRASILEIRO (NYSE:PBR)
TAIWAN SEMICOND ADS (NYSE:TSM)
ITAU UNIBANCO ADS (NYSE:ITUB)
CHINA MOBILE LIMITED (NYSE:CHL)
HDFC BANK LTD (NYSE:HDB)
BANCO BRADESCO ADS (NYSE:BBD)
KB FINL GP INC (NYSE:KB)
VALE S.A. ADS (NYSE:VALE)
CHUNGHWA TEL ADS (NYSE:CHT)
CHINA LIFE INS CO (NYSE:LFC)
TEVA PHARMACEUTICAL (NYSE:TEVA)
UNITED MICROELECTRC (NYSE:UMC)
INFOSYS TECHNOLOGIES (NYSE:INFY)
AMERICA MOVIL, S.A.B (NYSE:AMX)
Based on Yahoo Finance's estimated EPS for the next year, the top 15 holdings’ average forward P/E is 17.2 (Note: PBR and CHL’s P/E is current P/E).
EEMs’ biggest sector is Financial, which accounts for 25.4%. Energy is 15.3% and Materials is 14.9%. Emerging markets climbed in part because they tend to be heavily dependent on financials and materials companies, both of which benefited from government stimulus plans around the world.
Short-sellers and hedge funds, though sometimes shadowy, are sometimes seen as the smartest guys in the room. They've done their homework and they'll bet their capital against the crowd. Other than UNITED MICROELECTRC (UMC), the stocks mentioned above don’t massive short ratios.
Warren Buffett has a clear strategy for making money. His first rule of investing is: don't lose money. With a current P/E of 23 and a forward P/E of 17, based on the average of EEM’s top 15 holdings, emerging markets overall are certainly not cheap. People buy into bubbles for various reasons: the desire to "get rich quick" or to seek comfort. If you can avoid it, the worst thing that happens is the market keeps rallying and you miss out on the bull market.
However, investors (especially people near retirement) face two main financial concerns – longevity risk and inflation. In order to boost your overall returns, emerging markets should remain 10%-20% of your long term portfolio.
The chart below shows that when EEM pulled back 10% in November 2009, heavy volume entered into the market and pushed shares back to current levels.
Disclosure: I have long positions in EEM and CHL. Data is from iShares, Google and Yahoo Finance as of January 8, 2010.