The South African economy gives you an opportunity to capitalize on growth throughout the African continent while maintaining access to the liquid market you need.
Within the entire emerging market universe, the top performer last quarter was a relatively obscure name, giving investors exposure to foreign stocks they can’t get into anywhere else — and it’s now getting liquid enough to give active traders a chance to strut their stuff.
We regularly compare the nations of China, Brazil, South Korea, Taiwan, South Africa, Russia, India, Mexico, Malaysia and Indonesia against the broader Vanguard Emerging Markets ETF (VWO, quote) to see where momentum is picking up and where it lags. The following is an assessment of six country ETFs that are showing strong outperformance potential relative to broader emerging markets.
As Algeria ramps up the pressure on Orascom, it now looks unlikely that the company’s crown jewel Djezzy will be part of a planned $6 billion telecom merger with Russia’s Vimpelcom.
After Russian president Vladimir Medvedov himself failed to get a firm promise that Algeria will let VIP (quote) take over Djezzy, Algiers turned around and demanded $193 million in currency trading fines from the troubled wireless company.
Added to a $230 million tax bill, Djezzy — and already debt-laden Orascom (ORSTF, quote) — now owe over $400 million to the Algerian government.
What is really at stake here is that Algeria covets Djezzy for itself. The country has right of first refusal on any attempts by a foreign entity to buy any Algeria-based business, and most recently squelched a $9 billion bid from South Africa’s MTN (MTNOY, quote) to buy ORSTF and Djezzy.
In order to avoid deeper problems, VIP has reportedly offered to sell Djezzy to Algeria for $7.8 billion, which is of course completely unreasonable. Algeria has suggested a price more along the lines of $2.5 billion.
As it is, Algeria can always simply nationalize the business and alienate foreign capital — a real risk in emerging markets.
Either way, Djezzy generates 40% of ORSTF revenue. Unless it comes along with the rest of the company, VIP’s controlling shareholders may rethink the deal. At the very least, ORSTF may end up as a much smaller piece of the combined entity, which would solve many problems at once.
VIP has been the center of bitter dispute between venture partners Alfa and Telenor (TELNY, quote) that only resolved by the complete restructuring of the company this spring. Rather than re-open those wounds with a new equal partner in the mix, Egyptian magnate Naguib Sawaris, restructuring the new deal may make more sense.
With 668 stocks from all over the world, the $40 billion MSCI Emerging Markets portfolio would be tough to replicate on your own. But how close can you get?
Buying all those stocks on your own would be folly, even if they were all publicly traded in ADR form. And since EEM (quote) is admirably diversified — even the most massive allocations are under 3% of the total portfolio — you cannot really just buy the top 10 holdings here and think you have it all.
However, while EEM is very granular on a holding-by-holding basis, it is surprisingly concentrated when it comes to the markets in which it invests. Yes, just 10 countries account for 88% of the total portfolio — and this is where a truly sophisticated investor can replicate and even fine-tune the global fund.
Let’s see what happens if we tinker with a few of the big weightings.
China accounts for 18.42% of EEM and this aspect of the portfolio is surprisingly concentrated, with only eight companies accounting for almost half that allocation.
If we break out China as a separate “mini-ETF,” then China Mobile (CHL, quote) takes up a whopping 10% of the “portfolio” and China Telecom (CHA, quote) represents another 6%.
On the other side of the trade, GXC (quote) leans even further from the banks to add a few percentage points to oil and technology — EEM does not even list Baidu (BIDU, quote) among its holdings, while GXC gives it a 3% weight.
With 15.86% of the EEM portfolio, the Brazilian allocation is surprisingly concentrated. Counting preferred shares, Petrobras (PBR, quote) accounts for 19% of this “mini-portfolio” and banks ITUB (quote) and BBD (quote) add up to another 20%. Vale (VALE, quote) adds 10%.
EWZ (quote) is roughly the same animal, so simply swapping it in for EEM’s Brazil holdings should be a wash. However, because EWZ is so top-heavy, sophisticated investors may investigate replacing a slice of that 15.86% large-cap allocation with a smaller-cap offering like BRF (quote).
South Korea and Taiwan
Lumping these two countries together because of their relatively limited single-market ETF coverage and export focus, South Korea makes up 13.2% of EEM and Taiwan adds 10.4%.
EWY (quote), the dedicated Korea ETF, is somewhat less concentrated.
In Taiwan, Taiwan Semi (TSM, quote) is the heavyweight at 17% of the “portfolio,” followed distantly by Hon Hai Precision (HNHPF, quote) at 8%.
Note that the Taiwanese EEM holdings are a lot less concentrated than any of the countries we have seen before, but EWT (quote) is even less concentrated.
Interestingly, South Africa, with a 7.91% weight, is more heavily represented in EEM than either Russia or India. EEM favors Sasol (SSL, quote) over MTN (MTNOY, quote) but the dedicated fund EZA (quote) basically switches the weightings.
So what happens if you replace the big 88% in EEM with dedicated single-country funds and then maybe buy a frontier markets fund like FRN (quote) with the other 12%?
Leaving fees and the hassle of building this granular portfolio out of it for the time being, the fund-of-funds approach would be up 5% so far this year. EEM itself is up only 1.5%.
Is EEM 350 basis points cheaper than any of the constituent funds we have been working with? No.
Is it more diversified? Not necessarily. Most of the funds in our fund-of-funds are just as diversified (or as concentrated), and FRN, the only real wild card, invests in exactly the same markets as the “little” 12% in EEM. In most cases, these are exactly the same stocks.
Is EEM just having a bad year? Maybe. But that is a question for index designers.
The World Cup is upon us, so as the world watches South Africa, we talked about the country’s unique investment proposition this week on CNBC’s Trading the Globe.
South Africa has spent about $5.5 billion to build stadiums, roads and high-speed trains as part of its overall program of preparing to host the World Cup this month. The government hopes that a higher global profile will help the country attract about three times that much in direct foreign investment.
Many investors still think about South Africa in terms of gold, and many of the world’s great precious metals names trade on the Johannesburg Stock Exchange: Gold Fields (GFI), RandGold (GOLD), Harmony Gold (HMY), AngloGold Ashanti (AU). With gold trading around record levels, these stocks are obviously in the spotlight.
While the country mines gold for export in the form of its famous krugerrands, it also has a developed domestic industrial and consumer economy.
Sasol (SSL) is one of Africa’s biggest oil companies and has an interesting chemical business as well.
Naspers (NPSNY) is a global media conglomerate. Standard Bank (SBGOY) is one of the great emerging markets financial groups. MTN (MTNOY) is a huge cellular network, while Millicom (MICC) also does a lot of business in South Africa.
For exposure to South Africa, the iShares ETF (EZA) is a great start. The portfolio is remarkably balanced — only 22% of its holdings are in gold miners — and offers U.S. investors a chance to buy into many consumer names that do not trade here.
More advanced traders can also work with the South African rand via the currency ETF SZR. The rand is often an interesting contrarian play because it is so closely associated with gold.
A dramatic upturn in coal and other mining activity in the first quarter generated more robust growth in South Africa than economists had expected.
South Africa’s Engineering News has the story: