Emerging markets via the ASX - Eureka Report article
The Australian dollar has fallen 10% in recent weeks, leading to unhedged shares in emerging markets rebound about 2.3% since July 1. This is hardly enough to have investors packing for an extended holiday in the French Riviera, although it is nice to see one growth asset class providing reasonable returns after a dismal time in investment markets.
This 'Close up' article takes a look at the iShares Emerging Markets Exchange Traded Fund (ETF). Similar to an index fund, an Exchange Traded Fund is an instrument that aims to mirror a particularly index, in this case the Morgan Stanley Capital International (MSCI) Index. The MSCI is key indicator of global markets. The MSCI EM (emerging markets) is a "sub-set" of the MSCI which, as you would expect, indexes emerging markets.
The key difference between and ETF and an index fund is that the ETF is listed on the stock exchange. In practice this means the fees for ETFs are cheaper than index funds but the price of the fund can be much more volatile, reflecting how prices move on a public exchange.
You can buy ETFs as you would usually trade shares, through either a discount or full-service broker. The stock code for the iShares Emerging Markets ETF is IEM.
What are emerging markets?
Emerging markets are those with developing economies. Examples of these economies include the BRIC economies (Brazil, Russia, India and China). The expectation is that these economies are still very volatile but with the capacity to grow at a higher rate than developed economies, and provide investors with higher returns. This fits in with the conventional investment that risk and reward are related. Emerging Markets exposure offers higher potential returns with greater risk (volatility).
Emerging markets performance
To the end of July 2008, Australian shares have provided an average return (as measured by the ASX 300 index) of 8.7% a year over three years and 14.39% a year over five years. Over the same period, emerging markets shares (as measured by the MSCI Emerging Markets Index) have provided a return of 14.31% a year over three years and 18.02% a year over five years. This demonstrates that over this three and five-year period, there has been a "premium" for investing in emerging markets.
It is worth keeping in mind that this premium is not risk-free: the expectation is that emerging markets exposure is more volatile and therefore would underperform developed markets over some periods.
The iShares Emerging Markets ETF has been listed in the US since April 7, 2003. To March 31, 2008, it has provided an average annual return of 22.49% in Australian dollar terms (that is, for an Australian investor).
The iShares Emerging Markets ETF has been listed in the US since April 7, 2003. To June 30, 2008 (just over five years), it reported an average annual return of 20.66% in Australian dollar terms (ie, for an Australian investor). The actual underlying investments had provided a return of 32.11% in US-dollar terms, with the appreciation of the Australian currency reducing the return for Australian investors.
Emerging markets are subject to political, economic and legal risks. Consider China: its government is a communist dictatorship and its legal system and property rights are far less certain that in a developed economy. In fact, most Chinese companies are majority government-owned. This offers investors far less certainty when compared to an investment in a developed economy.
Whenever you invest overseas, the question is always whether or not to "hedge" currency movements. As explained in a previous article (see Careful how you hedge your bets), my preference is for currency unhedged exposure. These reasons for this include:
The iShares Emerging Markets trust is unhedged.