By The Sizemore Letter<\/u><\/p>\n
There are three ways to get exposure to emerging markets, according to\u00a0Barron\u2019s\u00a0<\/i>Shuli Ren<\/a>:<\/p>\n I\u2019ve written about the first option recently, giving my recommendation on\u00a0choosing the right emerging market ETF<\/a>.\u00a0 The most direct route I have found is via the\u00a0EG Shares Emerging Market Consumer ETF<\/b>\u00a0(ECON<\/a>).\u00a0 The underlying holdings of ECON get about 90% of their revenues from selling within their home markets and other emerging markets, which is a stark contrast to most mainstream emerging market ETFs.<\/p>\n For example, the\u00a0iShares MSCI Emerging Markets ETF<\/b>\u00a0(<\/span>EEM<\/a>)<\/span>\u00a0is comprised of companies that, while domiciled in the emerging world, get a large chunk of their revenues from exporting to the West.\u00a0 Think\u00a0Samsung<\/b>\u00a0(<\/span>SSNLF<\/a>)<\/span>\u00a0and\u00a0Taiwan Semiconductor<\/b>\u00a0(<\/span>TSM<\/a>)<\/span>.\u00a0 (Whether or not South Korea and Taiwan are \u201cemerging markets\u201d or \u201cdeveloped markets\u201d is another debate for another day, but both countries are well represented in EEM.)<\/p>\n What about the Ren\u2019s second option, buying a global materials index?<\/p>\n I\u2019m not the biggest fan of commodities as an asset class.\u00a0 There were numerous studies in the early-to-mid 2000s that showed a basket of commodities offering \u201cequity like\u201d returns (such as\u00a0this one<\/a>) and recommending commodities.<\/p>\n But things have changed over the past decade; correlations between commodities has increased.\u00a0 As commodity mutual funds and ETFs such as the\u00a0PIMCO Commodity Real Return Fund\u00a0<\/b>(<\/span>PCRDX<\/a>)<\/span> and\u00a0iShares S&P GSCI Commodity-Indexed Trust\u00a0<\/b>(<\/span>GSG<\/a>)<\/span> have become popular, commodities that once traded largely independently of each other now get lumped together and bought and sold as a group. Furthermore, the financialization of commodities has caused their correlation to stocks to rise as well.\u00a0 So, the touted diversification benefits are now mostly moot.<\/p>\n Furthermore, most investors have little understanding of how commodities investing works.\u00a0 Outside of a few ETFs that hold the physical commodity, such as the\u00a0SPDR Gold Trust<\/b>\u00a0(<\/span>GLD<\/a>)<\/span>, most funds and ETFs use commodities futures.\u00a0 And the price of the underlying spot commodity is only one return driver.\u00a0 You also have to take into consideration the roll yield (or the return you from buying a futures contract and having its price converge to the spot price) and the return from the collateral (which is usually Treasury securities).<\/p>\n Well, the collateral returns\u2014which were significant in decades past\u2014have been close to zero in the age of quantitative easing.\u00a0 And due in no small part to excessive interest from new retail investors, many commodities futures have been trading in contango (i.e. have a negative roll yield).\u00a0 This means that futures investors actually\u00a0lose<\/i>\u00a0money every month relative to the price of the underlying commodity.<\/p>\n Why does this matter?\u00a0 Gorton and Rouwenhorst\u00a0wrote a paper<\/a>\u00a0that compared spot commodity returns to futures returns to see how commodities stack up as an asset class.\u00a0 Their \u201cinvestable\u201d futures portfolio had annual returns of 10.31% from 1959 to 2004.\u00a0 Yet the spot return was only 3.47%…which was actually lower than the 4.15% in inflation over the period.<\/p>\n This means that two thirds of \u201ccommodities\u201d returns were actually from the roll yield and the collateral\u2026neither of which is a source of return in today\u2019s market.<\/p>\n This brings us to multinationals.\u00a0 This is my preferred way to invest in emerging markets for most clients because, if done right, it is the best of all possible worlds.\u00a0 You can get emerging market growth from companies with Western management and subject to higher standards of governance and regulation.\u00a0 I call the strategy \u201cEmerging Markets Lite\u201d or \u201cEmerging Markets though the Back Door.\u201d\u00a0 But whatever you want to call it, it\u2019s a great way to invest the growth portion of your portfolio.<\/p>\n By and large, you\u2019re going to get a better selection of Emerging Markets Lite stocks in Europe.\u00a0 Want a few examples?\u00a0 How about consumer products and food giants\u00a0Unilever<\/b>\u00a0(<\/span>UL<\/a>)<\/span>\u00a0and\u00a0Nestle<\/b>\u00a0(<\/span>NSRGY<\/a>)<\/span>.\u00a0 Both are stable performers with long histories of paying and raising their dividends.\u00a0 And both have monster presences in emerging markets.\u00a0 Unilever gets nearly 60% of its revenues from emerging markets, and while that has\u00a0hurt the company this past quarter<\/a>, it ensures that it has a bright future.\u00a0 Nestle gets more than 40% of its revenues from emerging markets.<\/p>\n Exposure to emerging markets is a double-edged sword. You benefit from the growth, but you also get whacked by the occasional currency crisis and by the occasional bout of political instability.\u00a0 Just consider it a cost of doing business.\u00a0 The rise of the emerging market consumer is a durable investment theme, and any macro shocks that cause Emerging Market Lite stocks to take a short-term tumble should be viewed as a buying opportunity.<\/p>\n Charles Lewis Sizemore, CFA, is the editor of the\u00a0Sizemore Investment Letter<\/a>\u00a0and the chief investment officer of investments firm Sizemore Capital Management. As of this writing, he was long ECON, UL and NSRGY.\u00a0Click here<\/a>\u00a0to learn about his top 5 global investing trends and get your copy of \u201cThe Top 5 Million Dollar Trends of 2013.\u201d \u00a0This article first appeared on InvestorPlace<\/a>.<\/em><\/p>\n This article first appeared on Sizemore Insights as The Best Way to Invest in Emerging Markets<\/a><\/p>\n\n