Growth in the European Union has slowed to a crawl, and Eastern European countries have not been able to dodge the pain. Despite the recent sell-off in the markets, the Eastern European exchange traded funds have bounced back about 6% since the market lows, compared to the European ETFs that have come back about 3%.
The definition of “emerging market” varies depending on who you ask, but generally speaking, these economies have a low- to middle-per capita income per person. They might sound like small fry, but these countries account for 80% of the world’s population. They’re considered emerging because of where they are with infrastructure, reforms and the practices of their governments. These economies are in transition, progressing from closed to open market economies. [ETF Strategies for Frontier and Emerging Markets]
While Emerging Europe encompasses many Eastern European countries, only a few countries have their own country-specific ETFs, including Russia, Poland and Turkey. However, investors who are loath to place bets on these countries alone may consider investing in a broad basket of Emerging European countries. [Europe ETFs for Good and Bad Times]
Emerging Europe
- iShares MSCI Emerging Markets Eastern Europe Index Fund (NYSEArca: ESR)
- SPDR S&P Emerging Europe ETF (NYSEArca: GUR)
The iShares Emerging Market fund is heavily weighted in Russia at 72.18%, followed by Poland 17.60%, Hungary 4.43%, Czech Republic 4.01% and Luxemburg 0.38%. The fund also leans toward the energy sector at 46.55%, followed by banks 19.09% and materials 15.19%.
The SPDR Emerging Europe fund allocates 65.07% in Russia, 13.85% in Turkey, 12.23% in Poland, 4.63% in the Czech Republic and 4.22% in Hungary. Top sectors include energy 42.72%, financials 21.57% and materials 13.63%.
Due to the two fund’s heavier weighting in Russia, the energy sector will play a major role in the performance of the funds as Russia is a large energy producer.
Russia
- iShares MSCI Russia Capped Index Fund (NYSEArca: ERUS)
- SPDR S&P Russia ETF (NYSEArca: RBL)
- Market Vectors Russia ETF (NYSEArca: RSX)
- Market Vectors Russia Small-Cap ETF (NYSEArca: RSXJ)
Russia is a large producer of oil and natural gas, with almost three-quarters of its public companies in the oil and energy business. Additionally, the country is rich in other raw materials, including coal, timber and various industrial metals.
Russia single-country ETFs are heavily weighted toward energy, materials and financial sector stocks. With the energy sub-sector accounting for around half of these funds’ overall weightings, Russia ETFs have been susceptible to the wild swings in energy prices, especially over the last few years.
Additionally, it should be noted that the ETFs hold securities denominated in the Russian ruble and they do not hedge currency risk. Consequently, any appreciation or depreciation in the Russian ruble against the U.S. dollar will positively or negatively affect the funds’ performance after converting back to the U.S. dollar. If you would like a pure play on the movements of the Russian ruble, you might consider trading in the Rydex CurrencyShares Russian Ruble Trust (NYSEArca: XRU).
Still, investors who believe the U.S. dollar will depreciate and see energy prices rising in the future may consider gaining exposure to this commodities-based economy. Russia is a major supplier of energy to the European bloc and it is also in close proximity to the quickly growing emerging Asia.
Additionally, the government has made moves towards attracting foreign investments. Russia is beginning to loosen its hold over state-controlled companies by selling minority stakes to foreign investors.
Potential investors need to be aware that widespread corruption poses a major risk to Russian equities. Transparency International, an anti-corruption watchdog, ranks Russia as the world’s most corrupt major economy, putting Russia 154 out of 178 in its corruption perception index for 2010. This is particularly alarming given the fact that the government has its hand in a lot its economic sectors, including the state-owned oil giant Gazprom.
Poland
- Market Vectors Poland ETF (NYSEArca: PLND)
- iShares MSCI Poland Investable Market Index Fund (NYSEArca: EPOL)
Poland is emerging as a bastion of growth in Europe, boosted by its floating currency, the zloty. As the euro currency has strengthened over the last few years, the zloty has depreciated, keeping Poland’s export industry competitive. On the flip side, as the financial problems struck the Eurozone and the euro currency, Poland’s independence from the euro has helped guard against the problems facing its neighbors.
The two Poland funds are weighted toward the financials energy sectors, which combined make up more than 50% in the two funds. It is this heavy weighting toward the financial and energy sectors that have helped depress the Poland ETFs amid concerns over the future outlook on global growth.
Poland’s finance minister has prepared for a potential second financial crisis if the financial problems in the E.U. were to escalate, stating “We forecast this crisis [on financial markets]and we were prepared for it … We launched one of the fastest and most effective programs of public finance improvement,” during a plenary debate on a government economic report.
Government projections and World Bank estimates put Poland’s GDP growth slightly above 4% for 2011; however, unemployment at just under 12% remains a problem – Poland is viewed as a source of cheap labor for the rest of the continent. Additionally, continued financial duress in the eurozone and signs of slower economic growth has diminished consumer demand, especially in Germany, Poland’s main trading partner.
Turkey
- iShares MSCI Turkey Investable Market Index Fund (NYSEArca: TUR)
Turkey has been posting remarkable GDP expansions, showing an 11% growth year-over-year in the first quarter and an 8.9% economic expansion for 2010. The country’s economic engine has been run by its industrial sectors. The rapid growth, though, has caused some volatility in the country’s inflationary reading.
The Turkey ETF holds almost half of its weighting in the financials sector. Credit growth has been showing signs of weakness in recent weeks, but the outstanding credit levels remains quite robust. Meanwhile, financing on the country’s ballooning current account deficit has mainly come from foreign borrowing as foreign direct investment has been dropping.
Investment Options
Potential investors who would like to select country stocks may choose among the country-specific ETF options available or gain exposure to the whole region through the Emerging Europe ETF theme. Additionally, one should keep in mind that all these funds have heavy weightings toward energy and financial sectors. As such, investors may not want to hold all these funds or risk becoming overexposed to these two sectors.
Read the disclaimer; Tom Lydon is a board member of Rydex|SGI.