Avoid These 3 Emerging Market ETFs

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Emerging markets, once the engine of global growth, have been hit hard this year due to feeble demand, lower commodity prices, and struggling currencies.  

Further, the prospect of the Fed’s QE3 tapering later this year has compelled investors to pull out capital from higher risk markets across the globe (read: Emerging Market ETFs Tumble on Global Worries). This is because investors are apprehensive of added troubles in the emerging nations from further dollar appreciation and this strong dollar impact on these risky markets.

That said, the two most popular emerging market ETFs – iShares MSCI Emerging Markets ETF (EEM) and Vanguard FTSE Emerging Markets ETF (VWO) – together shed nearly $11.5 billion in the first half of 2013. Investors are largely looking outside the emerging economies, indicating deeper troubles for these countries.

IMF Cuts Growth Outlook

In such a backdrop, the IMF recently lowered its growth forecast for the emerging nations to 5% for this year and 5.4% for the next. According to the agency, the slowdown in emerging nations would persist longer than expected due to prolonged domestic capacity constraints, slowing credit growth and weak external conditions.

The worst performers would include the BRICS (Brazil, Russia, India, China and South Africa) nations. The IMF slashed 2013 economic growth outlook by 0.5% to 2.5% for Brazil, 0.9% to 2.5% for Russia, 0.2% to 5.6% for India, 0.3% to 7.8% for China, and 0.8% to 2% for South Africa.

For Mexico, the growth rate is expected to decline from 3.2% to 2.9% for 2013 (read: Time to Worry about the Mexico ETF?). Other emerging economies in the sub-Saharan Africa region as well as the Middle East and North Africa are also expected to remain weak, with growth forecasted to fall 0.4% to 5.1% and 0.1% to 3.9%, respectively.

Emerging Market ETFs To Avoid

In such a backdrop, we recommend investors to keep away from many emerging ETFs at least for the short term.

Below, we take a closer look at three emerging ETFs that have lost double digits in the first half of the year. This weakness could continue into the second half of the year, given the bearish fundamentals for these economies, suggesting the following three ETFs might be ones to avoid (read: Winning ETF Strategies For the Second Half).

iShares MSCI BRIC ETF (BKF)

This fund tracks the MSCI BRIC Index, having accumulated $465.5 million in AUM and trading in average daily volume of roughly 190,000 shares. The product is well spread out across a large basket of 315 stocks as each security makes up for less than 4.35% share.

In terms of sector exposure, financials take one-third of the assets while energy and consumer staples together make up for another one-third portion. The Chinese firms dominate the portfolio with 41.4% share, closely followed by double-digit allocations of 25.5% in Brazil, 16.1% in India and 14% in Russia (read: Are BRIC ETFs in Trouble?).

The ETF charges 66 bps in expense ratio and lost nearly 16.5% in the year-to-date timeframe. BKF currently has a Zacks ETF Rank of 4 or ‘Sell’ rating.

iShares MSCI South Africa ETF (EZA)

EZA is one of the main sources to play the South African economy by tracking the MSCI South Africa Index and provides exposure to 50 securities. The fund manages an asset base of $458.9 million and trades at volume levels of roughly 370,000 shares a day.

The product is somewhat concentrated in its top 10 holdings as it invests more than 58% of total assets in those. The fund is skewed towards financial and consumer discretionary sectors with 27.38% and 20.42% share, respectively. The ETF charges 60 bps in fees and expenses from investors for this portfolio.

The ETF has delivered a negative return of 18.1% year-to-date, as the fund continues to be affected by troubles surrounding the country. The fund currently has a Zacks ETF Rank of 5 or ‘Strong Sell’ rating (read: Why You Should Avoid the South Africa ETF).

SPDR S&P Emerging Middle East & Africa ETF (GAF)

This is the only choice in the space that focuses on the emerging Middle East & Africa region. The product follows the S&P Mid-East and Africa BMI Index and holds 138 securities in its basket. It is relatively unpopular with AUM of $66 million and average daily volume of only 12,000 shares while charges 59 bps in fees a year from investors.

The fund is highly dependent on its top three holdings – Naspers, MTN Group and Sasol Ltd –that make up for at least 26% of the total assets. From a sectors look, financials take the top spot with less than 30% share while consumer discretionary, materials and telecom round off to the next three spots.

In terms of country exposure, the product allocates 92.8% to South Africa while Egypt, Morocco and Australia make up for a small portion in the basket (read: Egypt ETF Surges Despite Political Turmoil). GAF lost 14.8% in the year-to-date timeframe.

Bottom Line

Investors should note that these products have clearly underperformed the broader emerging market funds like VWO and EEM by wide margins (see more in the Zacks ETF Center). The near-term pain could continue in these funds, especially if investors start to believe in the Fed’s stimulus tapering plan.

Moreover, other drivers that might shift investors’ focus from these emerging nations include the monetary stimulus packages in Europe and Japan that provide the much-needed relief to their economies, as well as expectations of above-market performances by some other country ETFs like in Southeast Asia, and certain Eastern European economies.

Given this, investors may want to avoid these funds for the time being, though risk tolerant long-term investors may want to consider this recent slump a buying opportunity, provided they have the patience for extreme volatility and are willing to tolerate more losses in the near future.

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Read the analyst report on GAF

Read the analyst report on EZA

Read the analyst report on BKF

Read the analyst report on EEM

Read the analyst report on VWO

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