Looking at Bric and beyond

Emerging markets are increasingly seen as the way through the economic crisis, as Emma Dunkley reports

Emerging markets are proving to be the stalwart survivors of the financial storm, showing a high level of resilience amid the global economic crisis. While the US and UK, among other developed economies, are still grappling with the recession, the emerging markets are showing a significant and speedy rebound. 

“Emerging markets will lead us out of the global recession – this is a great time to invest in them,” says Global Trends Investments president Tom Lydon. He says Chile’s gross domestic product (GDP) has increased to 8% and India’s GDP has risen back up to 7%. 

While the main emerging markets, which typically consist of Brazil, Russia, India and China (Bric), offer investors growth opportunities through the rebound, each individual market also presents its own distinct benefits. Brazil and Russia, for example, are highly correlated to the performance of commodities, while China and India are driven more by their demographics, offering low-cost manufacturing and service industries. 

Lydon adds: “ETFs are efficient vehicles for tracking the emerging markets, because they are transparent and show exactly what the fund holds. Today, investors are very conscious as to what they’re investing in.” 

Top performer

In terms of three-month daily performance total returns, the Direxion Daily Emerging Markets Bull 3x Shares ETF is the best performing, delivering 67.05%. The ETF provides three times the daily performance of the MSCI Emerging Markets index. Direxion Funds vice president of trading Paul Brigandi says that the underlying benchmark comprises Brazil, weighted at 15%, China at 12%, South Korea at 11%, Taiwan at 10% and South Africa at 9%, along with smaller holdings in India and Russia. 

In contrast, the Direxion Daily Emerging Markets Bear 3x Shares ETF, which inversely tracks the same benchmark, delivered the worst performance over the same three-month time period, at -65.46%. Brigandi says that leveraged ETFs are always going to be at the top or the bottom of the charts, because they amplify the movements of the underlying index, therefore emphasising any index increases or decreases. He explains that these are products largely designed for sophisticated investors, with the aim of delivering enhanced daily returns for typically short-term investments. In order to provide the leverage, Direxion uses total-return swaps and futures transacted with various counterparties. 

Advantages

“Investors are opting for ETFs on emerging markets to provide broad diversification, as investors will not always know about investing in specific emerging markets,” Brigandi says. “ETFs provide investors with a way of trading these markets in a more liquid form, with tight spreads.”

ETFs also help with access. “These ETFs provide investors with access to countries which they might not otherwise be able to tap into,” he says. For example, the average investor might find it difficult to trade on local exchanges in Brazil, as they may not be familiar with the local processes such as settlement issues. Also, companies outside of the US should have American Depositary Receipts (ADRs) to trade in the US, and ADRs are not always liquid. 

Indeed, investors are less inclined to pick individual stocks given the volatile markets and might find it difficult to not only access certain emerging markets, but to know which stocks to select. Ricardo Kaufmann, head of full service brokerage at Bulltick Capital Markets, says: “Clients are less inclined to do stock picking and volumes in ETFs have grown so much that it’s easier for a client to approach the emerging markets through an ETF, which is extremely cost efficient.” 

He explains that since Brazil has rebounded and become such an important part of investors’ allocations, Bric has again risen in popularity. He says: “The iShares MSCI Brazil has massively grown in assets - more than half of the trades we do are through the iShares MSCI Brazil.” 

Route into emerging markets 

In terms of performance, the broader iShares MSCI Emerging Markets Index ETF, which tracks the respective index, is one of the better performing ETFs over the three-year period, returning 39.52%. This follows the top performance from the BLDRS Emerging Markets 50 ADR Index ETF, which returned 52.20% over the same time period. 

Claus Hein, Lyxor executive director of ETF sales, highlights that certain investors do not have foreign-investor access and would require local brokerages in order to access some of the emerging markets. “Being able to trade an ETF in European hours, denominated in euros, sterling or dollars in the European market is definitely an efficient way to gain exposure to this market.” 

He says that Lyxor’s set of emerging market products has seen net inflows and creations of €630m in the second quarter. The top three funds in terms of net new creations include the Lyxor MSCI AC Asia Pacific Ex Japan ETF, which Hein says provides accurate benchmark tracking through synthetic replication, minus holding costs of 65 basis points. The fund raised $230m throughout the second quarter, representing the largest fund by net inflows, according to Lyxor data. 

“Our other popular funds include the Lyxor ETF China, which has seen almost $216m in net new assets in the second quarter. The fund, which is 65bps, in line with our other emerging market ETFs, provides exposure to the Chinese market by tracking the Hang Seng China Enterprises index, consisting of H-shares listed on the Hong Kong Stock Exchange.” Hein adds that the fund now has around €840m in assets under management. 

Indian benchmark

Lyxor’s ETF tracking India has also proved popular, reaping almost $135m in new assets over the second quarter. The fund is also the largest Indian equity ETF in Europe, with $900m in AUM, according to Lyxor data. “Not many people have the capability to replicate the exposure to an Indian large-cap benchmark,” says Hein. He explains that although some investors are able to access a number of securities within the Indian benchmark, it is difficult to gain access to the entire index and purchase every single underlying security. 

“The ETF industry has generally experienced a number of inflows from investors previously using actively managed funds or other structures to gain access to these markets,” says Hein. “In this environment, when investors are paying a lot of attention to liquidity, spreads, entry fees, exit fees and counterparty risk, ETFs for emerging market access is a very attractive proposition.” 

Emerging market ETFs