Emerging Markets Funds That Stayed Afloat

TheStreet.com

NEW YORK ( TheStreet ) -- Emerging markets have been sinking. During the past year, Vanguard FTSE Emerging Markets ETF lost 4.6%, while the S&P 500 gained 16.2%.

Analysts blame the poor results on a range of factors. Weak commodity prices hurt exporters in countries such as Russia and Brazil. In addition, investors dumped emerging markets holdings as fears mounted that the Federal Reserve's tapering program could disrupt markets.

But not all emerging markets ETFs have suffered equally. For the year, PowerShares Golden Dragon China returned 43.2% while EGShares Emerging Markets Consumer ETF returned 3.0%. WisdomTree Emerging Markets SmallCap Dividend lost 0.2%.

The top performers all excelled by emphasizing companies that rely on sales to domestic economies. Big holdings include such sectors as consumer staples and utilities. In contrast, the Vanguard FTSE ETF and other broad-based funds emphasize export-oriented sectors, including energy and materials, as well as banks, which finance exporters. In the past year, the exporters lagged.

Can the domestic businesses continue to lead this year? Maybe not. With oil prices soaring, some commodity producers are rising. But the consumer stocks should continue to thrive in coming years as the emerging markets move away from dependence on exports.

In the past, the emerging markets grew primarily by exporting commodities and simple manufactured goods. The first companies to achieve large scale were often in businesses such as oil and banking. The export sectors depended heavily on the health of customers in Europe and throughout the developed world.

Lately, export sales have weakened as developed economies slowed. That has set the stage for a new phase that could focus on domestic consumption in the emerging markets. Despite the problems in the developed world, local consumer sales remain healthy as millions of impoverished rural people enter the urban middle class.

Consumer sales should continue growing steadily, even if the overall economies slow. "These countries have rising incomes and young populations that will demand more consumer goods," says Jeremy Schwartz, WisdomTree's research director.

Should you dump broad-based emerging markets ETFs? No. ETFs such as Vanguard FTSE Emerging Markets and iShares MSCI Emerging Markets provide exposure to countries that should continue growing faster than the developed world.

But you should consider supplementing your holdings with a fund that focuses on different sectors. Besides generating better returns, the consumer-oriented funds have delivered smoother rides. "Consumer stocks are less volatile and have more consistent earnings growth than the natural resources stocks and the banks," says Marten Hoekstra, CEO of Emerging Global Advisors, which offers the EGShares ETFs.

EGShares Emerging Markets Consumer ETF holds some of the strongest names in the sector. A holding is Naspers , a South African company that provides e-commerce and media services. The company offers pay TV to six million households in Africa. Another holding is Companhia de Bebidas Das Americas , a beverage company that produces and distributes Pepsi, Budweiser and other brands throughout Latin America.

PowerShares Golden Dragon China has achieved strong results by following an unusual approach. The ETF only takes companies that are listed in the U.S. and derive most of their sales from China. The resulting portfolio has most of its assets in technology and telecommunications. The biggest holding in the PowerShares fund is Baidu , the dominant Chinese search engine.

The fund only has 9% of assets in basic materials, financials, and energy. In contrast, iShares China Large-Cap -- the biggest China ETF with $5.1billion in assets -- has 71% of assets in basic materials, financials, and energy. The PowerShares approach has paid dividends. During the past five years, the fund returned 2.7% annually, while the iShares ETF lost 1.8% annually.

WisdomTree Emerging Markets SmallCap Dividend ranks as one of the top performers in the sector. During the past five years, the fund returned 6.1% annually, compared to 0.3% for iShares MSCI Emerging Markets. Because it only takes stocks that rank in the bottom 10% according to market capitalization, the WisdomTree fund excludes many of the giant exporters that dominate the four biggest emerging markets -- the so-call BRIC countries of Brazil, Russia, India, and China.

Instead, the small-cap fund holds sizable positions in such countries as Malaysia and Thailand. Those have strong consumer stocks that should continue growing.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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