To profit from emerging market ETFs, be prepared to do your homeworkNiche is so now. Specific, narrow, on target. Whatever you care to call it, that's what many folks want. In the land of Exchange Traded Funds, that even extends to emerging markets. Why settle for broad market exposure when you can get a sliver of something exotic?

In the last few months alone there's been a spate of specialized emerging market ETFs like Emerging Global Shares INDXX China Infrastructure Index Fund (CHXX), Global X Funds Global X China Consumer ETF (CHIQ), Emerging Global Shares INDXX Brazil Infrastructure Index Fund (BRXX) and Claymore China Technology (CQQQ).

"Investors are looking for investment opportunities that access economic growth around different parts of the globe," points out Greg Savage, managing director of iShares portfolio management group at BlackRock. "Whether it is due to economic stimulus or demand for natural resources, different regions and countries are recovering at different rates."

The chief advantage of this form of investing, says Savage, is the ability to specifically target countries and regions with the highest economic growth and/or exposure to specific sectors.

Access to Emerging Markets

For example, iShares ETFs provide access to many different emerging market countries, each with exposure to various economic factors. iShares MSCI Taiwan Index (EWT), for instance, is approximately 60% weighted in technology with close ties to the high-growth economy of China, says Savage. iShares MSCI Brazil Index (EWZ), on the other hand, is about 52% weighted in materials and energy.

Investing in the broad basket of emerging countries through iShares Trust MSCI Emerging Markets Index (EEM), in comparison, provides exposure to all emerging markets and their developing economies. This shift is not insignificant.

"Investors have cost-efficient access to segments of international markets that have historically only been available to large institutions," says James Ross, senior managing director at State Street Global Advisors.

But, before you set off on an overseas adventure, there's much to consider. For one thing, potentially greater returns generally mean added risk, says Robert Holderith, CEO of Emerging Global Shares. Exposure to certain narrower categories can carry more or less risk than the overall market.

Homework Required

"As you would when you invest in any ETF, do your homework," advises Holderith. "What is the Beta or relative risk of the fund? What percentage of the fund do the top 10 holdings represent? In emerging markets, political risk may be as important a consideration as the types of securities that underlie the fund."

Keep your risk tolerance in mind. For more conservative portfolios, Randy Brown, chief wealth strategist at Briteline Wealth Management, would use a broader index ETF like MSCI Emerging Markets Index or a BRIC ETF that invests in the growing economies of Brazil, Russia, India and China.

For a more aggressive portfolio with a higher risk tolerance he would use more specific single-country ETFs (Brazil, China, Turkey, Mexico and emerging nations of Asia, for example), based on economic growth in those countries. In addition, he uses ETFs for emerging market debt (emerging market bond funds, sovereign debt funds, etc.) as part of a fixed-income strategy.

Know what you're getting into by researching the country you want to invest in.

"You should feel comfortable with the political and economic environment of the country you're investing in," says Mike Halloran, vice president of market strategy for BPU Investment Management. "If you don't understand the country, you should be concerned about your exposure to it."

Broad Basket

If you're not comfortable with your level of knowledge of an individual country, another way to go is with "a broad basket of developing countries," Halloran adds. For those investors he suggests ETFs that give exposure to entire emerging markets, or groups of major countries within emerging markets. For example, a BRIC would provide exposure to the related economies of Brazil, Russia, India and China.

Keep an eye on fees, of course. And like elsewhere, liquidity matters, especially in case a crisis hits the country where you are invested. Expect more volatility the smaller, more narrow, or less liquid the investment vehicle.

"Beware of small, illiquid ETFs based on narrow indexes," says Marilyn Plum, chief investment officer, Ballou Plum Wealth Advisors. What else concerns her? "They have a short performance history. They don't always track their index and they can have wide bid/ask spreads, again because of small trading volume."

These investments should be portfolio components or satellites, not core holdings, says Holderith. And with sector or industry investments, quality research is important to increase the likelihood of success, he adds. Diversity rules here, too. "Spreading your risk across multiple emerging market countries is usually a good idea to diversify currency exposures," he adds.

So if you want to be adventurous, says Holderith, "Be prepared to do a bit more homework and to take profits or losses if the reason you purchased the ETF no longer exists."


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