Profit From the “New Decoupling”

Tony Daltorio, The Investment U Research Team

Emerging markets first hit investors’ radar screen about 20 or so years ago. There was a lot of skepticism and a lack of understanding about emerging markets, which was understandable because there were few emerging markets open enough (or large enough) to invest in with a degree of safety.

That has all changed in the past two decades as most emerging markets are open to foreign investments and have a high degree of liquidity. The number of so-called emerging markets has also grown from a mere handful to over 60.

Yet Wall Street seems to have missed these changes – there is still a lot of skepticism on Wall Street when it comes to investing in emerging markets. That is where the opportunity for investors lies.

Famed investor Jim Rogers says he likes to wait to invest until somebody else puts money down in the corner so he can “walk over and pick it up.” Well, Wall Street seems to have left a bundle of money labeled “emerging markets” for investors to go and pick up. Here’s why… and two easy ways you can do it.

Emerging Market Growth

The emerging market growth story has been a remarkable one over the past two decades – the story of the economic progress being made by about 80% of the world’s population. Some of the highlights include:

• Emerging markets recorded a combined annual growth rate of 5.5% over the past 20 years. Over that period, developed markets grew at a 2.3% rate.

• Emerging market companies have raised an incredible $1.4 trillion in IPOs and follow-on issues since 1989. This shows how far their financial markets have progressed over time.

• The weighting of emerging markets in the MSCI All Country World Index has risen from 2% in 1988 to over 13% today.

• In the period from 1998 to 2008, the market capitalization of emerging markets included in the S&P/IFC emerging market index rose from $300 billion to $7.5 trillion.

• During that same timeframe, the total number of companies listed in these markets increased from 5,400 to more than 15,400.

The New Decoupling

Wall Street has been quick to dismiss the idea of emerging markets decoupling from the developed world, especially the United States. Unfortunately, it may have been written off too hastily.

But there may be opportunity here.

Even if America’s economy remains weak, there are signs that some of the larger emerging economies could see decent economic growth. Exhibit A of this new decoupling is China. Most economists agree that output will grow faster than seemed plausible only a few months ago.

Economists now believe that China’s growth could be close to 8% this year, by any stretch that’s a blistering pace.

India’s growth estimates have also been ratcheted higher. This optimism about economic growth has fueled a rally in commodity prices, which has brightened the outlook for Brazil and other commodity-producing countries. Because of its resilience to the current global financial crisis, Brazil’s credit rating is under review to have  in hopes of being upgraded to ‘”nvestment grade” .

That being said, even the best performing countries will grow more slowly than they did over the past several years. The emerging market resilience will not be universal, either. Eastern Europe’s indebted countries will suffer as global banks cut back and emerging economies intertwined with the United States, like Mexico, continue to be hit hard. So will smaller, trade-dependent countries.

The new decoupling is more narrowly focused and confined to the biggest and the least indebted emerging economies. That’s the part that Wall Street has missed.

The biggest emerging economies are less dependent on American spending than commonly believed. For example, over half of China’s exports go to other emerging economies. They have proven more able and willing to respond to economic weakness because of their strong financial positions . Many of the developed countries are the ones bumbling along, looking for a way to respond to the financial crisis.

Two Ways to Profit From the New Decoupling

How does an investor profit from the “new decoupling?” The best way for long-term investors to participate is through having a diverse portfolio of stocks in the more successful emerging economies. Here are two ways for investors to achieve that goal:

iShares MSCI BRIC Index Fund (NYSE: BKF)

This exchange-traded fund (ETF) has a portfolio of about 175 stocks from the  BRIC countries. Despite a gain in excess of 40% year-to-date, the fund is still down over 30% over the past 52 weeks, so valuations are still not back to pre-crisis levels.

The breakdown for the ETF by country is as follows: China and Hong Kong: 42%, Brazil: 32%, India: 13% and Russia: 13%.

The top 10 components of the fund consist of many large new global giants. They are: China Mobile, Gazprom, Reliance Industry, Petrobras, Vale, Itau Unibanco, HDFC Bank, China Life Insurance, Lukoil and Industrial & Commercial Bank of China.

Templeton Emerging Markets Fund (NYSE: EMF)

Our second choice is a closed-end fund. The reason for this choice is simple – the manager of the fund is the emerging market guru, Mark Mobius. Mobius has been with the Templeton since 1987 and has blazed the trail for emerging markets investors.

In his portfolio, Mobius has the largest allocations to the following countries: Brazil: 23%, China and Hong Kong: 23%, India: 10%, Russia: 9%, Thailand: 8%, Turkey and South Korea: 7% each.

The top 10 components in his portfolio include – Petrobras, Vale, Petrochina, Akbank, Denway Motors, Itau Unibanco, Sesa Goa, Banco Bradesco, Aluminum Corp of China and SK Energy.

What’s nice about this closed-end fund is that recently it has often traded below its actual net asset value. It is currently just 1% below . During recent panic sell offs, the discount has often reached 10%. What a bargain – getting Mobius’ expertise at a discount.

In summary, one of the greatest events in human economic history is unfolding – 80% of the world’s population is moving from poverty to a better standard of living. It’s an unstoppable, irreversible trend. A trend that will be profitable for long-term investors hang on for the ride.

Adding these two funds to your portfolio will give you a quick, easy way to participate .

Good Investing,

Tony Daltorio

If you’d like to find out more on uncovering some of the best foreign investments around the world, take a look atTthe Oxford Club’s New Frontier Trader Service.

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