Last year, it was China. This year, it’s Russia reminding investors that governments can make emerging markets investing treacherous.
Bottom line: The more autocratic a country is, the greater the potential is for the government in that country to do something that costs investors money. That’s a reminder that geographic exposure should be one of investors’ primary considerations when evaluating emerging markets exchange traded funds.
With that in mind, the Next Frontier Internet & Ecommerce ETF (FMQQ) is one of the emerging markets ETFs that investors might want to evaluate.
“But there is a broader lesson for investors to consider: when it comes to investing in autocratic countries such as Russia, the normal rules of picking stocks and bonds, such as valuations or the fundamental outlook of a company or country, can be rendered irrelevant overnight,” writes Morningstar analyst Tom Lauricella.
Good news: FMQQ has no exposure to Chinese stocks, and the fund recently materially reduced its allocation to Russian equities. Not being allocated to China could be a favorable trait for FMQQ investors when emerging markets stocks rebound.
“It was one thing to miss the risks of investing in Russia. It’s a country where most diversified investors have only a small percentage of their portfolio. It’s a different story for a country like China. Many mutual funds and stocks have hefty direct or indirect exposure to the country, and observers who had warned about Russia are encouraging investors to ask similar questions about China,” adds Lauricella.
Regarding regimes and geographic exposure, FMQQ allocates almost 40% of its weight to South Korea and India — two highly democratic countries. While Brazil, the fund’s second-largest geographic exposure, has its problems with corruption, the country’s elections and political system are not comparable to those of China or Russia.
Further enhancing the long-term allure of FMQQ is that the fund avoids state-owned enterprises (SOEs), or those companies where the largest shareholder is the state. That’s common in developing economies, particularly those with autocratic governments. History indicates that avoiding such stocks can be a sound idea for investors because those firms often generate sub-par long-term returns.
“Energy and natural-resources companies often have to partner with state-owned enterprises, which makes it very difficult to disentangle from the risks posed by a government that might be involved in war, human rights abuses, or have a considerable degree of corruption,” concludes Lauricella.
FMQQ has no exposure to those sectors.
For more news, information, and strategy, visit our Emerging Markets Channel.
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.