Just One ETF: Go Where the Growth Is

Oct.21.10 | About: iShares MSCI (EEM)
Just One ETF
Several times a week, Seeking Alpha's Jason Aycock asks money managers about their single highest-conviction position - what they would own (or short) if they could choose just one stock or ETF.

David Moenning is founder and chief investment strategist at TopStockPortfolios.com and president of his own RIA based in Chicago. He's been an independent money manager since 1987.

Which single asset class are you most bullish (or bearish) about in the coming year? What ETF position would you choose to best capture that?

Let me start by saying that my crystal ball is in the shop at the present time as the darn thing hasn’t worked that well since I bounced it off of a wall a few years back. But I’ll try my darndest to look forward to next year anyway.

Next, I should state for the record that I’m an equities guy and while I will own a bond now and again when I’m forced to, I prefer to search out profitable situations in the equities markets. Getting to the point, I’m of the mind that the emerging markets are going to be the place to be over the next year. And in terms of an ETF selection, I’m particular fond of the iShares MSCI Emerging Markets Index ETF (NYSEARCA:EEM) due to its liquidity and longevity.

How does EEM fit into your overall investment approach?

The investment approach we employ at both my money management firm and our website is based on four key tenets:

1. Own the best and ignore the rest

2. Go where the growth is

3. Seek “absolute returns”

4. Always, always, always manage risk!

In short, I’m of the mind that the emerging markets fit in well with my overall approach to the markets. First and foremost, this is a top-performing asset class which contains the fastest-growing economies on the planet. And while the class itself isn’t exactly low risk, we have the technology to deal with the beta presented by places like Indonesia, Singapore, India, Russia, Brazil, etc., by using appropriate hedging and risk management strategies. Thus, I am happy to hold a core position in the emerging markets such as the EEM and then “trade around” the position, using both trend-following strategies and beta enhancers during uptrends.

Tell us a little more detail about emerging markets - and what makes the area your top pick.

Probably the biggest key here is that I don’t want to own a stock if it isn’t performing. I don’t want to own an asset class if it isn’t performing. Nor do I want to own a region or country if it isn’t a leader. And since I want to “go where the growth is,” I am particularly attracted to the emerging markets. (Although truth be told, I’ve been a fan of the emerging markets since the late 1980s.)

The emerging markets are the fastest-growing economies in the world. According to Haver Analytics, emerging markets occupy eight of the top 10 positions in the list of countries with the best year-to-year change in GDP. These include Taiwan, China, India, Brazil, Mexico, South Korea, and Russia. The average year-over-year GDP growth rate of this bunch is 8.63%, which is obviously a smidge higher than what we’re seeing right now in places like the U.S., U.K., and the eurozone.

Next up, the emerging markets largely avoided the credit crisis because debt is not used heavily in these countries. For example, while the debt-to-GDP percentage in the U.S. is 96%, and is 410% in the U.K., Russia’s ratio is 31.7%, India’s is 21.6%, Brazil: 12.0%, China: 8.5%. The bottom line here is that the avoidance of debt has allowed the emerging markets to become the drivers of the current global rebound.

We should also note that the economies of the major emerging markets are characterized largely by rising employment (note the lack of the letters “un” here), increasing consumer confidence, and supportive demographics.

In addition, valuations tend to still be in decent shape in the emerging countries. For example, none of the members of the BRIC countries is currently overvalued while good valuations are easily found in Russia, China, and India.

Are there alternative ETFs that could be used to capture the same theme? What makes EEM your first choice?

The wonderful world of ETFs is exploding on almost a daily basis. And while there are more and more ways to play the emerging markets these days, we prefer to stick with the bigger, more liquid names such as the iShares Emerging Markets (EEM) and Vanguard Emerging Markets Stock VIPERs (NYSEARCA:VWO). And if you are looking to drill down into more specific countries, we currently own Singapore (NYSEARCA:EWS), Indonesia (NYSEARCA:IDX), India (NYSEARCA:EPI), and Chile (NYSEARCA:ECH), to name a few.

One key difference is that VWO has a somewhat lower expense ratio (0.27% vs. 0.72%); what's the compelling reason not to seek out lower expenses, considering the funds have a lot in common?

You make a good point and my answer boils down to liquidity and familiarity. Vanguard is known for low fees and when running an index fund, the lower the fees, the better the index tracking should be. And the VWO is actually the higher-rated fund in our research. However, I have used the EEM for years and am quite comfortable with the fund. In short, it has been around longer and offers a higher level of liquidity (although the VWO has plenty of volume for most investors).

Nearly half of EEM's holdings are in financials and industrial materials. What's your take on its exposure (or lack of exposure) to consumers - which has come up a lot in our interviews, as investors try to get into the rapidly growing middle class in emerging markets?

While this may be an oversimplification, the emerging markets are primarily resource / energy / materials oriented countries without strong consumer bases or brands. For example, one of the big complaints about China is the country’s GDP is dominated by exports. The West would prefer that Chinese officials focus more on becoming a consumption-based economy, and I think this concept can be applied to many of the emerging markets. Thus, until these countries can build stronger consumers, the stocks will continue to be in the resource, energy, banking and telecom sectors. The key here is for investors to understand that the emerging markets are resource-based and therefore not as diversified as the developed countries.

Does your view differ in any sense from the consensus sentiment?

Currently, the emerging markets are fairly popular. First, their performance has been superior. However, over the past few months, the class has been part of the risk/recovery trade. And more specifically, the emerging markets have benefited from the falling dollar, which has put the commodity/reflation trade back on the table.

However, while these factors have helped drive performance, I would not invest in the emerging markets solely on the direction of the commodity or falling dollar trade. Sure, a falling dollar provides a nice breeze at your back, but it is most certainly not the only driving force in the emerging arena.

What catalysts, near-term or long-term, could move the sector significantly?

At the present time, there is a large degree of uncertainty over the future of the global economies. It is said that if the U.S. sneezes, the world catches cold. As such, if the U.S. economy were to fall back into recession, the emerging markets, most of which are export-based, would struggle. But on the other hand, should the Fed succeed with its QE2 program and return the U.S to a more robust growth path, the emerging markets will benefit to an even greater degree.

What could go wrong with your pick?

The biggest risk at this time would be a double-dip recession in the developed countries. Next is the potential for a currency war to break out as countries race to push their home currencies lower as a means to improve their exports. And finally, should the Chinese governments become over-exuberant in their tightening campaign, growth could be affected significantly.

But all things considered, I’d much prefer to go where the growth is and then manage my risk along the way.

Thanks, David, for sharing your ideas with us.

Disclosure: Long EEM, as well as EWS, IDX, EPI and ECH.

Read more Just One ETF interviews »

If you are a fund manager and interested in doing an interview with us on just one stock or ETF position you'd hold, please email Rebecca Barnett.