Getting Contrarian With Emerging Market ETFs

Amid tumbling commodities prices and sliding currencies, emerging markets stocks have lagged developed markets peers in a big way this year. Investors have responded by sparking some of the largest outflows from emerging markets exchange traded funds trading in the US since the global financial crisis.

For example, the Vanguard FTSE Emerging Markets ETF VWO and the iShares MSCI Emerging Markets ETF EEM, the two largest emerging markets by assets, lost over $6.5 billion combined during the third quarter.

With outflows such as those from VWO and EEM, it is not a stretch to call emerging markets ETFs contrarian investments. Investors willing to buck the broader trend and embrace emerging markets funds need to be selective, but there are some ETFs that fit the bill as credible contrarian ideas at a time of noticeable weakness throughout developing world economies.

Russia

The Market Vectors Russia ETF RSX is arguably the epitome of a contrarian emerging markets bet. Last year, the largest Russia ETF trading in the US tumbled 47.2 percent, but the fund has rebounded to post a 12.3 percent year-to-date gain.

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With RSX up this year, the fund may not appear to have the makings of a true contrarian bet. However, investors should remember that a bet on RSX is a bet on an ongoing recovery in oil prices because Russia is the world's oil producer that is not a member of the Organization of Petroleum Exporting Countries. RSX is highly exposed to that theme because the ETF allocates 42.6 percent of its weight to energy sector, more than double its second-largest sector weight.

RSX as a contrarian is further validated by the fact that Russia is mired in its worst post-Soviet era recession and because the ETF is volatile compared to broader emerging markets funds. The Russia fund has a three-year standard deviation of almost 27 percent, according to Market Vectors data, compared to 13.8 percent on the MSCI Emerging Markets Index. Standard deviation measures an investment's volatility.

India

The WisdomTree India Earnings Fund EPI is another contrarian idea because the ETF has been a disappointment this year. After surging nearly 28 percent last year, EPI has shed 11.8 percent this year. Slack performances by Indian stocks are viewed as disappointing because as a net importer of oil, Asia's third-largest economy was expected to benefit from lower crude prices.

India's central bank and its policymakers are taking steps to bolster the economy. In late September, the Reserve Bank of India surprisingly cut interest rates by 0.5 percent, the fourth consecutive meeting at which RBI has pared borrowing costs. Even with steadily declining interest rates, India's currency, the rupee, is healthy relative to other downtrodden emerging currencies.

"Persistent foreign institutional investor (FII) inflows and a 48% jump in foreign direct investment (FDI) have pushed India’s foreign exchange (FX) reserves to an all-time high at $380 billion (including forward sales). This has given RBI ammunition and market confidence in the health of the rupee," according to recent WisdomTree research.

China

It can be argued that practically any China ETF currently fits the definition of a contrarian investment because over the past six months, eight of the worst-performing non-leveraged ETFs are China funds. That includes the SPDR S&P China ETF GXC, which has lost 19.4 percent over the past six months.

The fund is home to almost 370 stocks, or more than seven times the amount found in the largest China ETF. It is that deep bench that gives GXC wide exposure to a potentially recovery in Chinese equities.

Though GXC allocates over 32 percent of its weight to financial services stocks, many of which are state-controlled companies, a trait that is currently viewed as negative, the fund offers ample exposure to more glitzy Chinese stocks as well.

China ETFs should Chinese stocks rally because the fund devotes nearly a third of its combined weight to technology and consumer discretionary stocks. That includes some previously high-flying Chinese Internet names.