Investors can access emerging market equities through exchange traded funds, but people should also be aware of certain risks associated with this area of the international market, such as currency risks.
For instance, a popular emerging market strategy has been to ride out the growth in the consumer sector. Over the past five-year period, the underlying index of the EGShares Emerging Markets Consumer ETF (NYSEArca: ECON) generated an annualized return 20%, whereas the benchmark MSCI Emerging Market Index returned 9.2%, writes Morningstar analyst Patricia Oey.
While ECON includes many high-quality consumer brands, most of the fund’s components are domiciled in countries that are experiencing greater currency volatility. Specifically, the EGShares ETF is overweight South Africa 19%, Brazil 15% and Chile 7%, whereas the MSCI Emerging Markets Index has a lower 8% tilt toward South Africa, 11% Brazil and 2% Chile. [It Pays Off To Be Picky With Emerging Market ETFs]
Consequently, the added exposure could hurt ECON’s returns if the emerging currencies continue to depreciate against the U.S. dollar – if the local currencies weaken against the greenback, returns are lower when converted back into U.S. dollar terms.
“Like most funds that invest in foreign equities, ECON does not hedge its foreign-currency exposure, so the returns of this fund reflect the change in the prices of individual securities as well as the change in the value of their respective local currencies versus the U.S. dollar,” Oey said.
The underlying countries are heavy commodity exporters and are suffering u nder the currently weak commodities market. For instance, South Africa’s miner strikes have cut down its metals exports, uncertainty in Brazil has weakened the economy, and Chile’s large copper industry has been pressured by the drop in base metal prices.
Nevertheless, ECON provides a decent targeted exposure to a growing area of the emerging markets.