If Emerging Markets Rebound, Go Small

Emerging markets equities and the marquee U.S.-listed ETFs tracking these stocks have been hammered in recent weeks. If the iShares MSCI Emerging Markets Index Fund EEM cannot eke out a gain today, the ETF will have closed lower for seven consecutive days. Sine the start of November, EEM has slid 2.1 percent. Overall, 2012 has been a year of mixed results for emerging markets investors. Due to an array of problems such as inflation, slowing growth and currency issues, the BRIC quartet has been disappointing. The average year-to-date return offered by the iShares FTSE China 25 Index Fund FXI, the iShares MSCI Brazil Index Fund EWZ, the Market Vectors Russia ETF RSX and the WisdomTree India Earnings ETF EPI, the four major ETFs tracking the BRIC nations, is just 1.33 percent. What that says is that the largest emerging markets have been duds. The news is not all bad. As Dorsey Wright & Associates notes, investors are becoming more apt to differentiate among various developing nations. Said differently, savvy investors know there is much more to the emerging market game than the BRIC quartet and South Korea. Should this asset class rebound before the end of the year, investors would do well to consider the following ETFs tracking smaller emerging markets. PowerShares DWA Emerging Markets Technical Leaders Portfolio PIE Over the past month, PIE's allocations to smaller emerging markets such as Malaysia and Thailand have helped the ETF prove more durable than a fund such as EEM. Investors can see what a difference larger allocations to the top-performing emerging markets makes when comparing PIE and EEM. PIE is off 1.6 percent in the past month while EEM is down four percent. Yes, South Korea and Taiwan, two of the most usual emerging markets suspects, combine for 20.5 percent of PIE's weight. However, Indonesia, Malaysia, Thailand, Mexico and the Philippines combine for nearly half of PIE's weight making the ETF one of the better multi-country options for gaining exposure to the best growth stories in the emerging world. iShares MSCI Philippines Investable Market Index Fund EPHE This is what happens: As certain emerging markets show improving equity markets, those markets gain more backers. Ruchir Sharma, head of emerging markets at Morgan Stanley's asset management, spoke favorably of the Philippines in a recent interview with the Financial Times. To be sure, the Philippine investment thesis has progressively gained backers in the West throughout this year. Followers of this space know EPHE was endorsed in January. The Philippines does not even account for one percent of EEM's weight and that should not matter to investors. What is important are the facts EPHE has proven durable relative to the broader emerging universe during market pullbacks and that the ETF has been a relative strength lead for the bulk of 2012. Market Vectors Indonesia Index ETF IDX Although Indonesia is the fourth-largest country in the world by population and the largest economy in Southeast Asia, it accounts for a scant percentage of the MSCI Emerging Markets Index. Try less than three percent. IDX is an interesting case. As has been noted, some country ETFs have recently been outpacing the major bourses in their home nations. Indonesian stocks recently hit record highs, but a weakening currency dampened those returns in U.S. dollar terms, the FT reported. In part, that explains why IDX is nowhere near its all-time high. To the fund's credit, it has been quite durable amid the recent calamity that has afflicted so many emerging markets ETFs. iShares MSCI Turkey Investable Market Index Fund TUR In the FT interview, Sharma also mentioned Turkey as one of his top picks in the emerging world. That is a good call, because like the Philippines and EPHE, Turkish equities and TUR have actually notched small gains in the past month. And like EPHE, TUR has had supporters dating back to much earlier this year. Fitch Ratings recently moved Turkey's credit rating to investment-grade territory. "Turkey's sound banking system underpins the rating. It has a capital adequacy ratio of 16.3%, is moderate in size and has a low non-performing loan ratio of 2.8%. However, credit growth has been brisk in recent years (although it slowed to 14% in September 2012), raising the loan/deposit ratio to above 100%. Household debt is low at only 18% of GDP," Fitch said at the time. Similar action by either Moody's Investors Service or Standard & Poor's would be significant because it would allow Turkish bonds to be included in benchmark fixed income indexes. The medium- to long-term bull case for Turkey is strong and an other credit rating upgrade would serve to fan the flames of a rally in TUR. For more on emerging markets ETFs, click here.