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How to Play the Emerging Markets



May 27, 2009 – Comments (0) | RELATED TICKERS: EEM , HDB , AMX

The Shanghai market is slammin'. Has the next investing bubble begun?

That was the question posed in an article recently sent to me from that postulates that the MSCI Emerging Markets Index (EEM) has gotten ahead of itself and that you, as an investor, should be wary.

As it turns out, the EEM ETF is a 4-star rated security in CAPS, and it is a reasonable and low-cost play on long-term growth in the emerging markets. But if you're willing to put forth some effort, I think it's worth your time to go it alone with a diversified portfolio of emerging markets stocks or to supplment an ETF like EEM with a few picks to alter your overall country and industry exposures.

Here's why
My problem with EEM -- as with most emerging markets indexes -- is that it's overweight in financials (the sector accounts for 22% of the portfolio, according to iShares) and it's relatively underweight in mainland China (the country accounts for just 11% of the portfolio versus 12% in Taiwan and 12% in South Korea). Finally, according to Morningstar, fully 86% of the portfolio is in "Giant" and "Large" caps.

So ask yourself if you really want to invest in emerging markets by buying shares of large financials and other large companies that are generally focused on being low-cost exporters of products (generally electronics and natural resources) to the US and other developed markets. This isn't how I want to play the emerging markets. Rather, I want to own China and I want to own companies that will play on the rise of the domestic consumer in these countries. EEM has some of that in its top 25 holdings in India's HDFC Bank (HDB) and Mexico's America Movil (AMX) -- both, incidentally, Motley Fool Global Gains recommendations that we actively follow -- but it doesn't have nearly as much as I would like.

Back to the bubble question
Finally, is it just me, or is it inane to call an "emerging markets bubble." The world's emerging markets are a wildly diverse group of countries that are being pushed and prodded by a wildly diverse group of forces. China, obviously, is a mega-exporter of low-cost goods. Peru, on the other, would benefit hugely if metals prices rebounded. Add in places like Vietnam, South Africa, Brazil, India, and Indonesia, and I find it impossible to believe that these countries, their prospects, and their valuations are all moving in lock step.

If you're going to be a savvy investor, you need, as Templeton advises, to have a global perspective. And that means eschewing catch-all labels such as "international" and "emerging" in favor of careful studies of individual companies and countries. That, I think, is some work that will pay off handsomely in the long run.

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