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Charles Lewis Sizemore, CFA
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Charles Lewis Sizemore, CFA is the Chief Investment Officer of Sizemore Capital Management LLC, a registered investment advisor. He has been a frequent guest on Bloomberg TV and Fox Business News, has been quoted in Barron’s Magazine, The Wall Street Journal, and The Washington Post and is a... More
My company:
Sizemore Capital Management
My blog:
Sizemore Insights
My book:
Boom or Bust: Understanding and Profiting from a Changing Consumer Economy
  • Investing in the Emerging Market Consumer Using ETFs 1 comment
    Aug 11, 2010 12:20 PM | about stocks: CHIQ, BRAQ, TEF, PM, EEM

    I’ve been a fan of the exchange-traded fund (“ETF”) as an investment vehicle for a long time.  In many ways, it was the perfect antidote to the mutual fund.  Only Congress, in its infinite wisdom, could have given us an investment as poorly designed as the mutual fund.  To create a way for the average American to invest alongside wealthy capitalists, they made a product with all of the contradictions of socialism.  In a mutual fund, all investors are punished for the actions of the few.  When assets under management are growing, the consequences are minor.  But when redemptions significantly outpace inflows, the fund manager has to sell positions to raise cash—creating taxable gains for all remaining investors in the fund. 

    It actually gets worse than that, however. 

    In a traditional mutual fund you can get stuck with a hefty capital gains tax even if your investment loses money! 

    Let’s say a fund owns Citigroup, and the manager happened to get lucky and bought Citi near its 2009 crisis low at $1.00.  If the manager decided to sell and take a profit on that position the day after you purchased shares in the fund, you get the privilege of paying taxes on that position’s 300% capital gains even though you enjoyed none of them.  In fact, if the market takes a turn for the worse and you later sell your mutual fund shares for a loss, you’re still on the hook for the capital gains on Citi. That hardly seems fair.  But such is life under the U.S. tax code for mutual funds.

    To be fair, there are some great mutual funds out there run by managers that keep tax efficiency in mind.  I’ve highlighted Albert Meyer’s Mirzam Capital Appreciation Fund (MIRZX) and the Vice Fund (MUTF:VICEX) in prior issues, and I continue to be a big fan of both.  The Mirzam fund has virtually no turnover (less than 2%), as Albert Meyer is a manager with a Warren Buffettesque long-term time horizon.  The Vice Fund has a higher turnover at 59%, but is still well below the industry average of over 100%.

    When you are looking for exposure to a specific sector or country, active management is less important.  You’re looking for “beta” exposure to an entire asset class or subclass.  In these cases, investing in an index fund is the way to go.  The problem with index mutual funds, as I discussed above, is that they can be woefully tax inefficient when inflows and outflows are large relative to the funds’ average assets under management.  This is a big problem for smaller funds or funds that trade in niche markets that can quickly go in or out of style—such as country or sector funds.

    This brings us to the original purpose of this section: using ETFs to get exposure to the Emerging Market Consumer.  ETFs avoid many of the tax issues that plague mutual funds.  Investors pay capital gains if the index is rebalanced, but the buying and selling by other investors has no effect on each individual investor’s taxable gains. 

    Emerging market ETFs are nothing new, of course.  The iShares MSCI Emerging Market ETF (NYSE: EEM) has been around for years.  The problem is that it’s a terrible way to play emerging markets.  EEM gives you exposure to large multinational firms from developing countries—firms like Taiwan Semiconductor and Samsung.  Both of these firms live and die based on their exports to the West.  You’re getting no real exposure to the underlying development of their home countries—Taiwan and South Korea, respectively.

    Global X Funds, a relatively new entrant in the ETF sphere, has created two funds that address this issue and focus directly on the emerging market consumer: 

    ·         The Global X China Consumer ETF (NYSE: CHIQ) ·         The Global X InterBolsa FTSE ETF (NYSE: BRAQ)

    I’m innately conservative—some would even say stodgy.  I prefer to play emerging markets through indirect means such as through Sizemore Investment Letter holdings Philip Morris International and Telefónica.  These firms offer great exposure to emerging market consumers while still benefitting from the stability of being domiciled in well-regulated, developed markets. 

    I need to do a little more research before I make either of these new funds an “official” Sizemore Investment Letter recommendation, but I wanted to make my readers aware of them. 

    For those readers looking to implement the ideas expressed in the SIL with something with a little more zing to it, Global X’s two consumer funds are an interesting opportunity. 

    Consumer stocks should be less volatile than energy, financial, or industrial stocks, but that doesn’t mean that they can’t fluctuate wildly during a broader emerging market sell-off, should one occur.

    Disclosure: Long TEF and PM
    Stocks: CHIQ, BRAQ, TEF, PM, EEM
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  • Destin
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    The China consumer ETF just popped up on my radar and while searching I stumbled upon this post, which was well worth the time. I will look forward to your future observations and evaluations.
    17 Aug 2010, 07:26 PM Reply Like
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