Foreign affairs

Invest-Notes has always been a big advocate of investing in enterprises operating beyond the borders of the United States. And while the world has not turned out to be quite as flat as predicted during the close of the last millennium, this increasingly volatile terrain remains a viable place to look for foreign investment opportunities. Almost a quarter of my personal retirement accounts are invested in stocks and bonds from non-U.S. companies.

Among the sectors that can be found across international equities, the most (in)famous is likely Emerging Markets. The most popular exchange-traded fund (ETF) proxy for this sector is EEM, iShares MSCI Emerging Markets. Up around 35% since the regime change in Washington, DC a year ago, this remains a scary place for many individual investors. Crushed during the market mayhem in 2008-2009, EEM has taken a longer, more volatile route back to a solid uptrend. Which might just make this a time for those without exposure in this space to consider adding some international flavor.

A quick comment before we do some analysis. Early on Emerging Markets was a catchphrase for the BRIC counties – Brazil, Russia, India and China. These days Mexico, South Africa and Taiwan also play supporting roles with walk-ons from countries like Turkey, Thailand and the Philippines. All-in, most Emerging Market indexes offer up around 10% of total world equity capitalization making this suitable only as a small part of your total foreign investment portfolio. In my case, 6% is invested in a competitor to EEM, Vanguard’s VWO. Today we’ll compare and contrast these two ETFs with an eye to the future based on some recent events.

While the biggest difference between EEM and VWO is the number of stocks included in their respective portfolios, a quick comparison points up a couple of points to consider:

EEM – iShares Emerging Markets

  • MSCI index
  • 900 stocks with around 9% turnover annually
  • 1.25% yield
  • 27% of the index value is in the top ten stocks, seven of which are Chinese

VWO – Vanguard Emerging Markets

  • FTSE index
  • 4,000 stocks with around 13% turnover annually
  • 2.25% yield
  • 17% of the index value is in the top ten stocks, five of which are Chinese

In summary, EEM is far more concentrated, more exposed to China and offering a smaller yield. All of which makes VWO a more attractive holding using the metrics preferred here at Invest-Notes. But more significant, perhaps, is what the results of the 19th National Congress of the Communist Party of China could mean for investors holding Chinese stocks. The quick take is that President Xi Jinping has centralized his power, and that of the Communist Party, to an extent not seen since Chairman Mao.

Any notion that Xi would embrace free market concepts to advance the Chinese economy has been laid to rest, despite his time decades ago as an exchange student in Iowa. Ever-tightening control of the Internet, silencing of the press and political dissidents, along with stricter top-down management of the economy open up the possibility for government meddling in some of the world’s largest companies. Especially vulnerable are the two major Chinese-based Internet players Tencent Holdings (TCEHY), the largest holding of both EEM and VWO, and Alibaba (BABA) a top ten holding in both ETFs, that could potentially find themselves with a new major investor – the Chinese government. While not inevitable, it is also not an outlier event based on current trends in China. So, if you determine to add some Emerging Market holdings to your retirement accounts it might make sense to limit exposure to Chinese equities by going with VWO.

Finally, for those interested in adding some foreign investment exposure but with less risk, a good choice might be Vanguard’s VEU (8% of my IRA). Sporting familiar names like Nestle, Toyota and Novartis in the top ten holdings, it more closely resembles an international version of the S&P 500 and delivered solid, but less impressive returns this year than EEM or VWO:

VEU – Vanguard All-World ex-US Index Fund

  • FTSE index
  • 2,400 stocks with around 5% turnover annually
  • 2.5% yield
  • 8% of the index value is in the top ten stocks, only one of which is Chinese – yes, Tencent
This entry was posted in Investment. Bookmark the permalink.

Leave a Reply

Your email address will not be published. Required fields are marked *