Exchange traded funds (ETFs) that track China, other parts of Asia, Eastern Europe, South America and Africa are major destinations for investors. But they aren’t areas you should get into before first understanding the ins and outs.
Foreign markets, such as China and South America, are typical areas that attract waves of foreign investment. Many of these economies are experiencing enormous growth, but with that growth comes great volatility and more than your average risk. Brain Bloch for Investopedia reports on what it is that makes these overseas global funds so risky and how to alleviate this.
- Political and economic instability: The turbulent political climate in developing countries can lead to massive flights of capital from one sector to another. Russia, Malaysia, Mexico and Brazil, for example, are so dominated by demand for raw materials that their markets are highly volatile and susceptible to price moves. [Risk Can Be Healthy.]
- Mega-corruption: Even though the West is not exactly free of corruption, in the developing countries, it’s usually greater. There are many countries in Africa and South America, for example, where you simply cannot do business without resorting to bribery.
- Problems on a grand scale: In the States, people worry about unemployment rising from figures 5%, and in countries like Germany, 10%. But in South Africa, for example, despite the booming economy, unemployment is nearly 25%.
- Information underload: Information about companies in developing countries can be hard to come by. While the Internet has made research in the United States accessible and easily available, this is not the case in other parts of the world.
- Culture shock: It is not just the countries that differ from the United States, but money is managed and invested differently, too. Investors need to look particularly carefully at the specific nature of the funds in question.
Country funds can be a great diversification tool and can deliver returns as they grow, but the risk they come with means you should handle them with care. To find funds that are appropriate for your risk tolerance, there are two things to keep in mind:
1. Broad funds that have exposure to an entire class (emerging markets) or region (Eastern Europe, the BRICs, for example) have less risk exposure than funds that give exposure to just one country.
2. If you decide to invest in an overseas fund, do so with a trend following plan in place. By creating an exit and an entrance point, such as using the 200-day moving average, you can keep losses to a minimum and keep decisions from becoming emotional. [Lessons Learned in the Market Sell-Off.]
For more stories about trend following, visit our trend following category.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.