Indonesia Small-Cap ETF Finally Perking Up

The Market Vectors Indonesia Small-Cap ETF IDXJ debuted in March becoming the third ETF exclusively devoted to Southeast Asia's largest economy. The other two, the Market Vectors Indonesia ETF IDX and the iShares MSCI Indonesia Investable Market Index Fund EIDO, are success stories with almost $669 million in assets under management combined. That success has yet to trickle down to IDXJ, which has just $2.4 million in AUM. Part of the reason for the slow start for IDXJ, the first Indonesia small-cap ETF, was a slow start to 2012 for IDX and EIDO. Even when other emerging markets ETFs were performing well in January and February, IDX and EIDO were laggards. That laggard status was a sign that if and when investors sought less risky fare that IDX and EIDO would be among the most vulnerable ETFs tracking developing markets. That situation came to pass when IDX, which was flirting with $31 in April, plunged to the $24 area in June. IDXJ went along for that unfortunate ride. The small-cap ETF would fall from around $22 in April to $16 in June. Things did not get much from there as IDXJ fell below $15 earlier this month. Perhaps making matters worse for the fledgling new ETF is that it negatively diverged from its large-cap brethren. In the past three months, IDX has jumped 13.2 percent while IDXJ has slid 3.4 percent. Why The Divergence The reasons for the Indonesian large-cap/small-cap divergence go beyond lack of risk appetite. While Indonesia's economy and its economic reputation have soared in recent years, this is still a developing market. While Indonesia's economic and political outlooks have improved, many investors have not forgotten the country's past that saw it rank as one of the most volatile emerging markets. The U.S. or Canada Indonesia is not. Said differently, if global investors are shunning volatile emerging markets, they are not apt to be playing favorites between large- and small-caps. Part of the reason for the struggle of Indonesian small-caps and IDXJ can be tied to what is viewed as a heavy-handed approach by the government in the mining sector. Rich in natural resources, Indonesia has said it wants foreign investment in its mining industry only to make life difficult for the foreign firms looking to operate there. In June, the Indonesian government forced Freeport McMoRan FC to reduce its stake to 49 percent in its Indonesian unit through an initial public offering on the local market, and to pay higher royalties on its giant Grasberg mine, according to the Sydney Morning Herald. Government interference in natural resources production is something investors have come to expect in Latin America. That is to say, if the Indonesian government is not careful, it could squander an opportunity to attract foreign investment in its mining sector. This is relevant to IDXJ not because the ETF is heavy on materials names. It is not as the sector accounts for just 4.4 percent of the ETF's weight. However, energy names account for 12 percent of the fund's weight and financials receive an allocation of almost 41 percent. Combined, financials, energy and materials names are 57 percent of IDXJ's weight, meaning this ETF can be easily rattled by even the slightest hint of unfavorable government policy. Conversely, IDX is a bit more conservative. Yes, financials are the largest sector weight at 31 percent, but the ETF is more levered to the Indonesian domestic economy with consumer staples and discretionary names combine for almost 29 percent of that ETF's weight. Adding to the conservative mix is a combined 16 percent allocation to telecommunications, utilities and health care issues. Turning Around IDXJ's cautionary tale needs to be acknowledged. So must the fact that the ETF is showing signs perking up. Adding to the nascent bull case is the addition of five companies to OSK Investment Bank's OSK Top Indonesian Small Cap Companies for 2012 list, according to The Borneo Post. As of OSK Rsearch's cut-off date of March 22 2012, these 30 companies were trading at a combined price earnings multiple of 13.3 times for financial year 2012 forecast earnings with a return on equity of 24.6 percent and earnings growth of 55.3 percent, the newspaper reported. All of those figures are attractive relative to the overall Jakarta Composite Index. That is just one bank's assessment, but IDXJ has been performing well as of late. In the past month, the ETF is up 2.8 percent while the MSCI Indonesia Small Cap Index, not the index tracked by the ETF, is slightly lower. Over the past five trading days, IDXJ has jumped six percent and less than two hours into Monday's session, volume in the fund had already eclipsed five times the daily average. That move drove IDXJ above its 50-day moving average for the first time since May, perhaps indicating the move above $16 could see the ETF climb to its 200-day line at $18 in the coming weeks. For more on Indonesia ETFs, click here.