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Three emerging markets to spice up your portfolio

The economies of India, Mexico and Indonesia are showing promise

By: JOEL SCHLESINGER

Date: April 28, 2015

Emerging markets are often hailed as where the growth opportunities lie. Yet they are equally synonymous with volatility and risk.

They offer tremendous long-term potential for profit as they continue to account for a growing share of global GDP, already exceeding 50 per cent, according to IMF data. Despite the upside, most Canadians don’t invest in them.

In fact, less than one third of Canadians invest outside Canada, according to a recent Canadian Imperial Bank of Commerce survey.

But investors should take notice: The IMF predicts that the combined real GDP growth in emerging markets will be almost double that of developed economies such as Canada and the United States for the next two years.

Here are three countries to take a look at.

India

  • Real GDP growth 2014: 7.2 per cent
  • Forecast real GDP growth for 2015: 7.5 per cent
  • Forecast real GDP growth for 2016: 7.5 per cent

China is still the dominant emerging economy, but India, with its rapidly expanding middle class, comes a close second. Many observers consider its investment prospects superior to China’s, at least in the near term. Among them is Tyler Mordy, co-chief investment officer with Toronto-based Hahn Investment Stewards.

“The country’s resurgent economic optimism has been ramped up by a belief that newly elected pro-business Prime Minister Narendra Modi can return India to its high-growth path of the mid-2000s, triggering transformational development on a massive scale,” Mr. Mordy said.

He suggests two exchange-traded funds that provide diversified exposure to India:

iShares MSCI India ETF (BATS: INDA), with a management expense ratio (MER) of 0.68 per cent: This fund tracks the MSCI India Total Return Index, which represents 85 per cent of the Indian equity market weighted by market capitalization. Most of the exposure is to the technology and finance sectors, two of India’s strongest. Trading on the BATS Exchange, based in Kansas City, investors can get access through a licensed adviser or their online discount brokerage.

Market Vectors India Small-Cap Index ETF (NYSEARCA: SCIF), with a MER of 0.93 per cent: Mr. Mordy says investors with “higher conviction” about India’s prospects can get exposure to its small cap companies “positioned to benefit from increasing domestic demand” from its growing middle class. This ETF uses a proprietary, rule-based index to get exposure to companies with a minimum market capitalization of $150-million (U.S.). The companies also must generate at least 50 per cent of their revenue in India. Mr. Mordy says the index is mostly exposed to Indian companies in the financial, consumer discretionary and industrial sectors, “which would respond positively to strengthening consumer and infrastructure demand.”

Execution of Mr. Modi’s proposed economic and structural reforms is the chief risk to India’s economic growth, however. He may not be able to tackle its long-standing corruption issues, while ongoing efforts to tame inflation may fail, forcing the government and the central bank to abandon stimulative policies.

Mexico

  • Real growth 2014: 2.1 per cent
  • Forecast real GDP growth for 2015: 3 per cent
  • Forecast real GDP growth for 2016: 3.3 per cent

Mexico’s economy will benefit from the U.S.’s resurgence. Investors can get diversified exposure to its market using ETFs, such as the iShares MSCI Mexico Capped ETF (NYSEARCA:EWW), or they can invest in emerging market mutual funds such as the AGF Emerging Markets Fund, which is overweighted in Mexican firms. The fund has made substantial investment in the following two Mexican companies, according to one of its managers, Alpha Ba:

Grupo Financiero Banorte (MM: GFNORTEO): One of Mexico’s largest banks, Banorte recently underwent a management change and is now aggressively courting Mexico’s growing middle class. Another upside: It is deeply involved in financing smaller firms, which are difficult for Canadian investors to access otherwise. “So you buy the bank that finances them instead,” Mr. Ba says. In addition, Banorte has been growing its market share across Latin America. Banorte stock is sold only on Mexico’s stock market, making it difficult to invest in directly, but you can get exposure to it through most mutual funds and ETFs investing in the Mexican market. The risks to Banorte’s prospects are stiff competition from other Mexican banks as well as its ability to manage bad loans.

Walmex (OTC: WMMVY): Just like its parent firm, Wal-Mart Stores Inc., is to Canada and the U.S., Walmex is the dominant retail chain in Mexico. A separate entity from Wal-Mart, the company should benefit from increased consumer demand. “It’s basically a consumption play,” Mr. Ba says. Walmex stock can be purchased through licensed brokerages as an ADR (American Depository Receipt) via the over-the-counter (OTC) pink sheets market. The risks for Walmex include that it might turn out to be its own worst enemy in its quest to grow, simply due to its size, Mr. Ba says. “It needs bigger and bigger stores, and with that comes the risk of cannibalizing the existing base.”

Indonesia

  • Real GDP growth 2014: 5 per cent
  • Forecast real GDP growth for 2015: 5.2 per cent
  • Forecast real GDP growth for 2016: 5.5 per cent

Indonesia is another economy expected to benefit from the election of a pro-business government with a strong mandate for reforms, says Marco Lettieri, assistant vice-president of asset allocation and currency management at CIBC Global Asset Management.

Since his election in the fall, Indonesian president Joko Widodo has already significantly reduced fuel subsidies. “That’s freed more money that can be used for infrastructure and social spending,” Mr. Lettieri says.

Furthermore, falling energy prices ease inflation – a recent problem – so its central bank is expected to lower the interest rate – at present more than 7 per cent – in the next 12 months. “That reduces companies’ cost of borrowing, making them more profitable, and it also leads to more positive sentiment about the economy that attracts investment capital.”

Investors can choose from a handful of U.S.-listed ETFs that provide diversified exposure to the Indonesian stock market at a low cost, Mr. Lettieri says. They can also buy into the country’s banks.

Market Vectors Indonesia Index ETF (NYSEARCA: IDX), with a MER of 0.57 per cent: This ETF uses a rules-based, modified market capitalization weighting of mostly publicly traded Indonesian companies that generate the majority of revenue from the domestic market.

Indonesian banks: Two of the country’s largest banks, Bank Mandiri (OTCMKTS: PPERY) and Bank Rakyat Indonesia (OTCMKTS: BKRKY), should benefit from a falling-interest-rate environment as more businesses and consumers borrow money, which should encourage economic growth. Their shares are available as ADRs via OTC trading through licensed brokerages.

The potential downside for investing in Indonesia is similar to risks associated with India – the new government might not be able to implement reforms and fund productive public investment.

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