Emerging Market Catch All

There are something like four posts in the last couple of days at IndexUniverse about emerging market ETF flows including this very thorough article that had all sorts of data (it was ten pages long).

There is all sorts of ground to cover with this article. The first point is that of moderation. A reader left a comment to this interview about an advisor currently allocated 50-60% in emerging markets on the way to 70% (per the article). I should have something up at theStreet.com later today with more detail on this but right or wrong 50-60% is not moderate.

Over the weekend the WealthTrack program ran a couple of old interviews with Peter Bernstein (recently passed away) and one of the points he made was that some risks are simply too big to take. Too big is obviously in the eye of the beholder but the next time emerging markets drop 25% in a month out of the blue, and there will be a next time and then a time after that, a portfolio that heavily exposed will get crushed.

Emerging markets is a crucially important asset class, it has made a huge difference in results in this decade and may be more important next decade but in the context of working with a financial plan, targeting 7-8% annualized growth and assuming you are saving properly how much extra volatility do you think you need to take on in order for your plan to work? Then what is the risk you do the wrong thing because your allocation pukes down lickity split one month? I think people want to own an amount such that they do not panic out of anything after a big drop.



If you like broad based funds you probably get most of what you need (even if not an ideal exposure) from something like iShares Emerging Market (EEM). If from there you want to add a little octane you already know you can add a small position in a specialty fund of some sort to capture some outperformance. There are plenty of funds like that to choose from.

The next point is a response to the following quote addressing a possible reason for increased flows into EM ETFs;

a genuine pattern illustrating a general shift in the market from active to passively managed money in emerging markets.

From the beginning of this site I have been writing about using passively managed products in actively managed accounts. If you look at all the commentary about ETFs (both print and TV) it is obvious that this is becoming more popular. Two paragraphs above this one I give an example of this. Here is a more specific example. Someone has EEM as their core exposure, they believe emerging is going to take off for some reason so they add something like GlobalX Colombia 20 ETF (GXG). If the market is in fact going up then adding volatility becomes a good idea (the work is in selecting the right vehicle). Since GXG's inception in February EEM is up 40% and GXG is up 60%. This is not surprising, the time was right for emerging markets generally and there have been no coups or recession inducing natural disasters so that the Colombia ETF would outperform is not surprising.

To be clear, I think you need a fundamental basis for buying anything and I have no plans to buy GXG. After such a move, someone who fancies themselves as being an active trader might want to take the GXG off and go back to the core exposure.

This flows into the final point. If people really are gobbling up emerging market ETFs then I view that as a flashing yellow light. As I just mentioned EEM is up 40% in five months and now we are seeing people buying a lot? Taking a cue from Hussman I might think risks of a pullback outweigh the chance of more big moves higher for a while.

I included the chart above because I thought it was interesting but don't have a lot to say about it.