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How Did Indonesia Avoid the Emerging Market ETF Slump?

Zacks Equity Research

Having proven analysts wrong, Indonesian ETFs – highly vulnerable to the escalated Fed tapering – held up pretty well against the broader emerging market space to start this year. With a large current account deficit, tumbling currency, rising inflation and slowing growth, the biggest economy in Southeast Asia was poised to suffer more this year.

Investors should note that this economy returned only 3% in 2012 and plunged about 20% last year. While many thought the nation would undergo more suffering in 2014 thanks to the beginning of the end of a cheap-dollar era which will cause reversal in foreign capital flow, Indonesia ETFs surprisingly saw havoc returns so far this year.

Let’s find out how these managed to avoid emerging market sell-offs so far this year (read: 3 ETFs Tumble Most on Emerging Market Sell-Off).

Behind the Outperformance

Swing Back to Trade Surplus: Indonesia recorded a trade surplus in the last three months of the year with the biggest gain being witnessed in December thanks to continued improvement in exports. Exports in December grew 10.3% year over year against analysts’ estimate of just 1.80%.

A fragile currency – which lost about 21% last year – played its role to bolster exports while a ban on unprocessed mineral ore shipments effective mid-January expedited procurement of ores by the world ahead of the ban.  Investors should note that among various metal ores, Indonesia is the world's biggest producer and exporter of nickel, and accounts for 18–20% of global supply (read: Why Nickel ETFs Might Be a Great 2014 Investment).

Meanwhile, domestic consumption slipped to 5.3% from 5.5% in 4Q13 bringing the much-needed respite to the country’s current account deficit and easing the stubbornly high inflation. The trade surplus in December totaled $1.52 billion – the largest balance since December 2011 – on top of the November trade surplus of $790 million that breezed past the estimate of $550 million as polled by economists.

The uptick in exports, especially mineral ores, resulted in faster-than-expected GDP growth (5.72% y/y) in the final quarter of 2013, up from 5.62% in the previous quarter, breaching a two-year stretch of slowing GDP growth rate, as per trading economics.

General Election Another Windfall: Indonesia is due for its parliamentary election in April and has a presidential election in July. Thus, the possibility of an influx of campaign spending could bolster the companies that have more domestic exposure especially which are engaged in food, consumer staples and media businesses, as per Bloomberg.

A few of the leading investment managers of Indonesia appeared optimistic about the country’s stock market performance this year. Historically, Jakarta stock index added a massive return in the prior two election years – 87% in 2009 and 45% in 2004 and investors hope that history repeats itself in 2014 (read: Is it time to buy Indonesia ETFs?).

Market & ETF Impact

Thanks mainly to these abovementioned factors, the Jakarta Stock Exchange Composite Index gained modestly over the last one month while gains were more pronounced in the ETF world in the year-to-date time frame. iShares MSCI Indonesia Investable Market Index Fund (EIDO), Market Vectors Indonesia ETF (IDX) and Market Vectors Indonesia Small-Cap ETF (IDXJ) have returned 12.8%, 11% and 17%, respectively, while the broader emerging market fund,  iShares MSCI Emerging Markets ETF (EEM), lost 2.2% during the same time frame. Notably, smaller caps benefited more than the larger ones from the election spending.

EIDO in Focus

The most popular ETF tracking the Indonesian market is EIDO, a product that looks to track the MSCI Indonesia Investable Market Index. The fund invests $336.6 million in about 111 stocks, charging investors 62 basis points a year in fees for the exposure (see Southeast Asia ETF Investing 101).

EIDO is a bit concentrated in financials as it accounts for roughly 35% of assets, followed by consumer sectors which, if joined, make up a similar amount of assets. The product is also highly concentrated in the top-10 holdings with about three-fifth of exposure. It has a significant focus on large cap stocks (about 77%).

IDX in Focus

This is the oldest Indonesia ETF making a debut in January 2009. The product tracks the Market Vectors Indonesia Index and charges 59 basis point in fees which makes it a slightly cheaper choice.
IDX allocates its $184.4 million of assets to roughly 53 companies at time of writing. Large caps account for more than 80% of the fund.

The sector allocation pattern is almost the same as EIDO, as financials make for the top sector with about 31.5% taken by consumer staples (16%) and consumer discretionary (14%). However, the product has a diversified geographical approach thanks to the index’s focus on companies that do at least half of their business in the country and not necessarily those that are based in the nation. This gives IDX 21.2% exposure in China, 5.6% in Singapore and 3.3% in Thailand.

 IDXJ in Focus

This relatively new product from Market Vectors might entice investors willing to tap the smallest companies in Indonesia. The ETF tracks an index of small and micro cap securities that are heavily exposed to Indonesia, holding roughly 36 stocks in total. The fund charges 61 bps in fees.

Here also, the portfolio is pretty concentrated in financials, with more than two-fifth focus trailed by industrials (27.1%) and energy (16.1%). Still, the portfolio is relatively well-spread out from an individual holding perspective, as barring the top-three allocations, no single company makes up for more than 4% of the total.

Bottom Line

While things are now in favor of Indonesia, the country might fail to sustain this uptrend in the near future. As much as $500 million worth of monthly mineral ore shipments has stalled since mid-January due to the new policies. This badly timed policy will likely pull down the skyrocketed export figures of the nation which in turn will cast a shadow on GDP growth.

With 175 bps of interest rate hike last year and some more likely this year – thanks to more than 8% of inflation, consumer spending is expected to remain weak in the coming quarters thus leaving no scope for GDP to outperform.

On the other hand, pre-election campaign spending will likely be in place during the first part of this year. Amid such a backdrop, small-caps oriented fund IDXJ would be a wise bet if investors seek a touch of Indonesia in their portfolio.

We currently have Zacks ETF Rank #3 (Hold) for all three Indonesia ETFs, though they have clearly held up better than most in the emerging world in the face of the turmoil, and could be interesting developing market picks for later this year as well.

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