10 For ’13: Emerging Markets ETFs For 2013

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With 2013 finally here, reflecting back on the year that was for exchange-traded products can provide investors with some clues regarding what themes and trends will be hot this year. This is not a bold prediction, but it is reasonable to expect one of 2012′s hottest asset classes to stand tall again in 2013.

The asset class being referred to is emerging markets ETFs, both bonds and equity-based funds. While the final tally for 2012 ETF inflows has not yet been published, it is worth noting that emerging markets bond ETFs had hauled in $5.4 billion through the end of November.

iShares Dow Jones US Home Const. (ETF) (NYSEARCA:ITB)

In November alone, diversified equity-based emerging markets ETFs such as the iShares MSCI Emerging Markets Indx (NYSEARCA:EEM) raked in $1.8 billion in new capital, according to Morningstar data.

With the outlook, a bullish one at that, for emerging markets debt ETFs in 2013 having been previously highlighted, it is time to focus on which equity-based ETFs could present the best opportunities for investors looking to gain exposure to the developing world in 2013.

There are few things about this list to keep in mind. First, no fixed income funds are featured here. Second, only 10 country-specific ETFs will be featured here, in no particular order, but the universe of emerging markets funds is obviously many times larger. Third, given the sheer size of the emerging markets ETF universe, these are not the only funds that will be worth trading or investing in this year.

iShares MSCI Brazil Index (NYSEARCA:EWZ) A quick recap of EWZ’s 2012 performance would go like this: The largest ETF tracking Latin America’s largest economy was, quite simply, one of the year’s biggest emerging markets disappointments.

Coming off a year in which the fund tumbled 6.3 percent and was sharply outpaced by its small-cap equivalents, EWZ showed some signs of life in the last month of 2012, gaining 8.5 percent.

Just as EWZ’s 2012 misfortunes are easy to explain, so is the 2013 outlook for this fund. Brazil’s GDP has been shocking paltry in recent quarters. For the third quarter it was just 0.6 percent. That is not what investors are accustomed to emerging markets A smart investor is apt to wonder why it is worth taking the risk on an ETF with a beta of almost 1.8 against the S&P 500 when the U.S. is offering far superior GDP growth.

Bottom line: EWZ can offer investors a positive reversal of fortune in 2013, but the stars need to align properly for that to happen. Economic growth must improve, the Rousseff Administration must show foreign investors that Brazil is not as politically risky as it appeared in 2012 and Petroleo Brasileiro Petrobras SA (NYSE:PBR), EWZ’s largest holding, must cease being the laggard among global integrated oil stocks.

Market Vectors Indonesia Index (NYSEARCA:IDX) From one 2012 disappointment in EWZ to another in IDX. The oldest Indonesia ETF lost just 1.6 percent last year, but that performance is woeful compared to the returns offered by other ETFs tracking Southeast Asian nations such as the country-specific funds for the Philippines and Thailand.

With 2012 in the books, investors will be looking to see if IDX offers potential for a significant rebound in 2013. In fact, it does. Indonesia is Southeast Asia’s largest economy and the fourth-largest country in the world by population. Those factoids do not mean IDX should rise (or fall), but it is worth noting profits are increasing at large-cap Indonesian firms J.P. Morgan is sounding a bullish tone on the country.

What is crucial to the Indonesian investment thesis is that foreign investors take a proper view of the country. Meaning they must recognize that the country is not as export-dependent as many outsiders think it is. Indeed, exports account for 20 percent of GDP, but Indonesia is arguably the envy of much of the developing world because its consumers driver 60 percent of GDP.

The government expects 2012 GDP growth of 6.5 percent while the World Bank is forecasting 6.3 percent growth in 2013. A look at IDX’s sector lineup, which includes a 12.8 percent weight to staples names, shows the ETF is intimately levered to the Indonesian consumer story.

iShares MSCI Philippines Investable (NYSEARCA:EPHE) From a Southeast Asian disappointment in IDX to one of 2012′s shining starts in the iShares MSCI Philippines Investable Market Index Fund. EPHE was not only one of the region’s best-performing ETFs last year, it was one of the best among all emerging markets funds with a gain of almost 44 percent. A 44 percent surge in one year obviously begs the question can it happen again the following year?

Obviously, asking for a repeat of a 44 percent gain is asking a lot, so investors might do well to temper their expectations with EPHE in 2013. However, that does not mean the ETF will not impress again. Actually, the catalysts are in place for another strong year for EPHE.

Those catalysts include soaring GDP growth (7.1 percent in the third quarter, topping estimates of 5.4 percent) and a push for an investment-grade credit rating the Philippine government is far from shy about. Should the country’s economy continue on its current pace, it is unlikely that even slow-moving ratings agencies will let the country’s sovereign rating languish in junk territory much beyond the second quarter.

Another important factor to remember about EPHE and the Philippines is that, as Benzinga reported in January 2012, the country is not intimately dependent on exports to China to drive its economic growth. As the top business process outsourcing destination and the call center capital of the world, the Philippine economy is far less export-dependent than many think it is.

There are risks, though. The Philippines is home to rampant poverty and over-population. Those are cautionary tales on their own, but a reputation for corruption and graft presents an issue when it comes to attracting foreign direct investment.

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