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¡Hola! Four Hidden Plays on Continued Emerging Market Strength
By Michael Brush
Exclusively for InvestorIdeas.com
January 4, 2007
We missed much of the enormous gains in foreign markets last year because we follow signals from insider buying at U.S. companies.
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That may soon change.
During the holiday break, insiders bought shares at four closed-end funds run by Credit Suisse Asset Management that specialize in emerging economies.
These weren’t enormous insider purchases. But at least one of the fund directors who bought has a record for crafty market timing. And over the past year or so, two of these funds have handily beaten other plays on emerging markets – like comparable exchange traded funds.
So we’ll take ‘em.
The closed-end funds insiders bought were: the Emerging Markets Telecommunications Fund (ETF), the Latin American Equity Fund (LAQ), the Indonesia Fund (IF), and the Chile Fund (CH).
These funds give you exposure to anything from a hot wireless company in India called Bharti Airtel, to Philippine Long Distance Telephone, and venture capital firms like BPA Israel Ventures and JPMorgan Latin America Capital Partners.
These are actively-managed funds, and in the past year the handiwork of the managers has paid off.
- The Emerging Markets Telecommunications Fund advanced 52% in the past year, compared to 24.4% for the iShares MSCI Emerging Markets Index (EEM) exchange traded fund.
- The Latin American Equity Fund was up 34% compared to a 32.7% gain for the iShares S&P Latin America 40 Index (ILF) exchange traded fund.
- The Indonesia Fund advanced an impressive 88%, while the Chile Fund retreated 8%. If anything, the divergent performance of these two demonstrates the joys and risks of having excessive exposure to a single county.
Emerging market strength
You can buy these closed-end funds like stocks, on the U.S. exchanges. But before we get to more details, let’s deal with another issue: Is it wise to buy emerging markets after they’ve had such a healthy run?
Yes. But just remember that they can be extremely volatile. Be sure you have the stomach to handle a 25% paper loss without getting spooked into selling. It could easily happen, no kidding. That warning aside, here’s why emerging markets should do well – and outperform the U.S. markets – over the next several years.
- Emerging markets still have to grow into their britches. Emerging economies comprise half the world gross domestic product (GDP) and 45% of world trade, but emerging
stock markets account for only 12% of the world’s market capitalization, points out James Paulsen, an economist and market strategist with Wells Capital Management. That’s an imbalance that has to even out to some degree, over time. Paulsen thinks emerging economies will account for two thirds of world GDP in 20 years. “If you buy emerging markets and hold them for the next decade, it may be a rough ride, but you will do all right,” believes Paulsen.
- Despite the recent rally in emerging country stock markets, they are still fairly cheap. They are also cheaper than the U.S. markets. The reason: Fundamentals are so good that earnings have advanced a lot, points out Arjun Divecha, of Grantham, Mayo, Van Otterloo, a money management firm that invests in this arena.
- Outsourcing is still a big theme. That may not be good for workers in North America who lose their jobs, but it’s great for business in places like India, China and Mexico.
- The dollar should continue to weaken. This makes commodity prices go up – and many emerging market economies deal in commodities. The downside is that emerging market exports will get more expensive. But countries like China will make up for it in productivity gains, believes Ed Yardeni, a market strategist with Oak Associates. Besides, a stronger yuan would discount the prices for the huge amount of commodities that China has to import.
For all these reasons, I think it makes sense to buy at least two of the four closed-end funds we recently saw insiders purchasing. Again, be sure you have a multi-year time horizon – because you could see volatility and nasty surprises along the way. Emerging markets, for example, retreated sharply in December when Thailand seemed like it was going to put limits on foreign currency flows, but then pulled back.
Closed-end funds
Like stock mutual funds, closed-end funds typically have managers who are paid to make stock picks. Unlike mutual funds, these vehicles have a fixed number of shares outstanding. You don’t purchase or redeem shares with a mutual fund company when you invest. Instead, you buy closed-end fund shares in the stock market, just like a stock.
This means the prices of closed-end fund shares are determined chiefly by market supply and demand for those shares. One odd outcome is that the market cap of a closed-end fund may diverge sharply from the underlying value of the investments it holds – called the net asset value.
Some investors believe closed-end funds are a “buy” when they sell at sharp discounts to their net asset value. But the truth is, they can carry that discount for a long time if the market continues to ignore the sector the closed-end fund operates in, for example. And there’s not much anyone can do about it except lobby to break up the fund, which is a difficult process.
These factors shouldn’t concern you if you are investing for the long term in funds with exposure to strong underlying growth – and that’s the case with emerging market closed-end funds. I’d guess that unless emerging markets go out of favor for a long time, you won’t see persistent, deep discounts to net asset value.
These four funds have reasonable expense ratios of around 1% to 1.25% of the fund’s market value. That’s about what you pay for a managed emerging markets fund at T. Rowe Price (TROW), or a reasonable actively-managed domestic fund, for that matter.
Emerging Markets Telecommunications Fund (ETF)
Insiders buying this fund recently included a director named Phillip Goldstein who is a clever market timer. He lightened up at that start of last year, selling 24,000 shares in the $12.80-$13.25 range. Then he bought back 10,300 shares in June when the fund shares slipped to $10.73. Recently he was buying again at $17.81, along with several other directors and the chairman of this fund.
This fund favors faster-growth wireless stocks (about 50% of the portfolio) like Bharti Airtel in India, over telecom companies offering fixed line service. It also likes telecom infrastructure stocks. “We believe that a number of emerging market counties have under-committed to infrastructure spending, which could provide good investment opportunities as they seek to catch up,” the fund wrote in a recent letter to shareholders.
Top holding recently included America Movil S.A. de C.V. which is a cell phone company in Mexico; China Mobile; MTN Group, a cell phone company in South Africa; and PT Telekomunikasi in Indonesia.
The fund is mainly concentrated in Asia (39%), Latin America (30%) and the Middle East (12%). It has the most exposure to Mexico (20%), China (12%), Russia (10%), and South Africa and Brazil (8% each).
Latin American Equity Fund (LAQ)
This fund invests chiefly in Brazil (60%) and Mexico (27%), but it also has a significant presence in Chile (7%). It recently had big exposure to mining, energy, wireless, banks and diversified telecom. Top holdings included Petroleo Brasileiro S.A., an energy company in Brazil; Companhia Vale do Rio Doce, a Brazilian mining company; and America Telecom, S.A. de C.V, a Mexican wireless company.
Indonesia Fund (IF)
This fund has done well in the past twelve months because of smart picks in utilities, real estate and telecommunications. Telecom and banks each make up about a quarter of the fund’s holdings. The top three stocks included PT Telekomunikasi Indonesia, PT Perusahaan Gas Negara Gas and PT Bank Central Asia.
Chile Fund (CH)
Stocks in Chile fell less than those in other Latin American markets during the May-June sell off. But they also bounced back less. So this fund was weak for the year. The fund recently favored beverage and retail stocks, as well as the paper industry and electric utilities. It was underweight telecom.
The bottom line: Despite the strong performance of emerging market stocks in the past year, they should still hold a place in your portfolio because they have several strong years ahead of them. These four closed-end funds are a way to play it. If you have to pick two, go with the broader funds instead of the country-specific plays. I’d put some money in now, and reserve some for the crisis that will inevitably hit emerging markets at some point.
Disclaimer
At the time of publication, Michael Brush did not own or control shares in any of the companies listed in this column. Mr. Brush is an independent columnist for this web site.
For more on Insiders Corner disclosure, see the disclosure section in About Insiders Corner:
http://www.investorideas.com/insiderscorner/.
InvestorI deas.com Disclaimer: www.InvestorIdeas.com/About/Disclaimer.asp . InvestorIdeas is not affiliated or compensated by the companies mentioned in this article.
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