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VIDEOInvesting in the Emerging Market Consumer Using ETFs
By
Charles Sizemore
Sep 07, 2010 11:30 am
How to be part of the most significant investment theme of the next 20 years.
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It actually gets worse than that, however.
In a traditional mutual fund you can get stuck with a hefty capital gains tax even if your investment loses money.
Let’s say a fund owns Citigroup (C), and the manager happened to get lucky and bought Citi near its 2009 crisis low at $1.00. If the manager decided to sell and take a profit on that position the day after you purchased shares in the fund, you get the privilege of paying taxes on that position’s 300% capital gains even though you enjoyed none of them. In fact, if the market takes a turn for the worse and you later sell your mutual fund shares for a loss, you’re still on the hook for the capital gains on Citi. That hardly seems fair. But such is life under the US tax code for mutual funds.
To be fair, there are some great mutual funds out there run by managers who keep tax efficiency in mind. I’ve highlighted Albert Meyer’s Mirzam Capital Appreciation Fund (MIRZX) and the Vice Fund (VICEX) in the past, and I continue to be a big fan of both. The Mirzam fund has virtually no turnover (less than 2%), as Meyer is a manager with a Warren Buffett-esque long-term time horizon. The Vice Fund has a higher turnover at 59%, but is still well below the industry average of more than 100%.
When you're looking for exposure to a specific sector or country, active management is less important. You’re looking for “beta” exposure to an entire asset class or subclass. In these cases, investing in an index fund is an acceptable way to go. The problem with indexed mutual funds, as I discussed above, is that they can be nearly as tax inefficient as actively managed funds when inflows and outflows are large relative to the funds' average assets under management. This is a big problem for smaller funds or funds that trade in niche markets that can quickly go in or out of style -- such as country or sector funds.
This brings us to the original purpose of this section: Using ETFs to get exposure to the Emerging Market Consumer. ETFs avoid many of the tax issues that plague mutual funds. Investors pay capital gains if the index is rebalanced, but the buying and selling by other investors has no effect on each individual investor’s taxable gains.
Emerging market ETFs are nothing new, of course. The iShares MSCI Emerging Market ETF (EEM) has been around for years. The problem is that it’s a terrible way to play emerging markets. EEM gives you exposure to large multinational firms from developing countries -- firms like Taiwan Semiconductor and Samsung. Both of these firms live and die based on their exports to the West. You’re getting no real exposure to the underlying development of their home countries -- Taiwan and South Korea, respectively.
Global X Funds, a relatively new entrant in the ETF sphere, has created two funds that address this issue and focus directly on the emerging market consumer:
I’m innately conservative -- some would even say stodgy. I prefer to play emerging markets through indirect means such as through Sizemore Investment Letter holdings Philip Morris International (PM) and Telefónica (TEF). These firms offer great exposure to emerging market consumers while still benefiting from the stability of being domiciled in well-regulated, developed markets.
At this point I'm not ready to make these two ETFs “official” Sizemore Investment Letter recommendations, but I wanted to make readers aware of them.
For those looking to implement the ideas expressed in the SIL with something with a little more zing to it, Global X’s two consumer funds are an interesting opportunity.
Consumer stocks should be less volatile than energy, financial, or industrial stocks, but that doesn’t mean that they can’t fluctuate wildly during a broader emerging market sell-off, should one occur.
The rise of the emerging market consumer is the most significant investment theme for the next 20 years. But as always, the initial price you pay is the most important factor in your long-term returns. Emerging market stocks are best purchased on pullbacks.
Positions in TEF and PM
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