Are you looking to diversify your holdings? Do you think that the stock market is overpriced or too expensive? In a separate blog, I looked at small cap stock exchange traded funds and mutual funds. Well, there is another asset class that has been hard hit in the recent months that could be attractive if you have the stomach to ride the roller coaster that is the emerging markets. Earlier in 2014 the emerging markets were on a tear and some exchange traded funds rose as high as 18 percent in the first half of the year, then over the second half lost over 10 percent of those very same gains.
So if the US markets were on an upward move almost all of 2014 what caused the emerging markets to decline? The answer to that is two-fold in my opinion is two-fold, and the first part of the issue is the cost of doing business in emerging markets. In many areas of the world and especially emerging market countries interest rates are much higher than in the United Stated and many developed nations in Europe and Asia. And with the end of the Federal Reserve’s bond buying associated with quantitative easing it stands to reason that at some point in 2015 domestic interest rates will rise. As the US interest rates go up the emerging markets will see an additional increase in their interest rates as well. As the rate continues to rise, the cost of doing business in these countries will continue to rise as well.
The second aspect to why emerging markets have decreased in value in recent months has been tied to the price of the principal commodities. Emerging markets that have the price of the equities related to commodities such as gold, silver, and crude oil have all seen dramatic decreases in the base price of the commodities recently. In the case of gold and silver the price of these commodities has been on the decrease for the last few years and could have bottomed out recently. Oil over the last two months has gone from above $100 a barrel to around $80 a barrel in recent trading. If emerging markets are tied to one of these three commodities, it is plain to see why the underlying stock value of the companies who deal with them have decreased as well. With many emerging markets having their economies tied to the export of these commodities and others like them, it is plain to see that they should and have decreased in value.
But investing in emerging markets allows for investors to diversify their portfolios beyond the traditional asset classes most of us are accustomed. But with this added diversification comes a lot of risks and volatility as well. With emerging markets being so volatile, the rewards of investing in them can be great as well. Since 2000 emerging markets have done better than large US based equities by about five percentage points annually.
Now investing in emerging markets is very similar to investing in small caps. The most economical ways are through mutual funds and exchange traded funds. But the two are very different in investing approaches and fees that are passed on to the investors in such funds. Actively managed funds tend to do fairly well when compared with a passive fund because fund managers can avoid certain areas or markets and concentrate on the ones performing better. An exchange traded fund is limited to investing in the index it follows regardless of the performance of the components that make it up. Now an actively managed mutual fund will cost about 1.6% in annual fees while an exchange traded fund will be closer to 0.6%. Like in small cap funds it is sometimes better to pay the management fee and have a chance at higher returns.
For more information on this and other topics feel free to contact me for more information.
