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Searching for returns in Southeast Asia

Adek Berry | AFP | Getty Images

Emerging markets always seem like a dangerous bet, and right now they may appear even more risky than usual. Rising interest rates have been known to hammer emerging economies. A strong U.S. dollar is also a headwind. And a trade war waged by the United States against overseas manufacturing could upend export-based markets. But that is not dampening investor enthusiasm. In fact, emerging markets are seeing renewed interest from investors. The iShares Core MSCI Emerging Markets ETF took in $1.7 billion from investors in January, No. 4 among all exchange-traded funds. January was the best month for the MSCI Emerging Markets Index in almost a year.

"Emerging markets fears are overdone," said Neena Mishra, head of ETF research at Zacks Investment Research. Fear of the strong dollar is losing steam — it has recently been trading near a three-month low. The market is now also betting that the pace of Fed rate hikes is not going to be as fast as it expected. Meanwhile, the macroeconomic situation in emerging markets is better than it was at the time of the Fed-induced Taper Tantrum of 2013. "Current account deficits have come down, and the fundamentals have improved," Mishra said.

But a broad emerging markets bet, like the iShares ETF, can be a bumpy ride at a time when the direction of Fed policy and the dollar trade remain in flux. That's why Mishra and other investing experts are taking a closer look at specific emerging market nations. Some of the most beaten-up emerging economies have surged, including Brazil and Russia, buoyed by the stabilization in oil prices. And China and India receive most of the attention when it comes to growing Asian economies. But Southeast Asian ETFs are also worth a look.

Emerging markets funds

ETF
YTD return (%)
1-year return (%)
YTD flows ($)
1-year flows ($)
iShares Core MSCI Emerging Markets (IEMG) 7.8 26.8 2.1 billion 9.5 billion
Schwab Emerging Markets (SCHE) 7.2 29 95 million 709 million
SPDR S&P Emerging Markets (GMM) 7.5 29 11.8 million 121 million
Vanguard FTSE Emerging Markets (VWO) 7 28.3 1.3 billion 9.1 billion
iShares MSCI BRIC (BKF) 9.1 36.3 0 (-35 million)

(Source: XTF.com, data as of 2/6/2017)

"A small hike is already anticipated," said Robert Madsen, economist on global affairs at David Hale Global Economics. "So the effect on Southeast Asia won't be much." Even a 75 basis-point rise won't do much damage, he said.

"These countries benefit from trade relations with China, Japan and the U.S.," Madsen said. "The result is a region which has 4.4 percent GDP growth this year and an expected 4.5 percent GDP rate next year. This growth can offset economic difficulties."

A strong U.S. economy that strengthens global demand has similar effects on Southeast Asia, said Tu Packard, a senior economist at Moody's Analytics.

Mishra is focused on another big advantage in some emerging Asian economies: a large domestic population, which in all adds up to 600 million. It's largely young and features a growing middle class, she said, factors that can make these economies more resilient to external shocks.

Mishra especially likes Indonesian ETFs. The country has a stable, growing economy and an administration that is showing good leadership, she said. In many ways, Indonesia is similar to India, which also has strong economic growth. "The mean middle-class age of 28 to 29 will be a big driver of growth, and the administration's initiatives are very good in terms of reform," Mishra said. "The domestic demand is high," she added.

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Mishra favors Indonesian ETFs with large-cap stocks: The iShares MSCI Indonesia ETF and the VanEck Vectors Indonesia ETF.

"Many of the stocks in it are attractively valued," said Todd Rosenbluth, director of ETF and mutual fund research at CFRA, speaking about the iShares MSCI Indonesia ETF. "And they're also relatively low risk." They also have a track record of paying dividends, he said.

Asian country funds

ETF
YTD return (%)
1-year return (%)
YTD flows ($)
1-year flows ($)
iShares MSCI India (INDA) 8.4 15 94 million 439 million
iShares MSCI South Korea (EWY) 10.7 24 0 (-528.4 million)
Van Eck Vectors Vietnam (VNM) 4.8 2.7 7.3 million (-62.3 million)
iShares MSCI Philippines (EPHE) 6.1 7.5 13.7 million (-68.5 million)
iShares MSCI Thailand (THD) 6 29.3 7.5 million 107.6 million
Van Eck Vectors Indonesia (IDX) 3.9 16.1 0 (-19 million)

(Source: XTF.com)

Some of the iShares fund holdings include the conglomerate Astra International and Unilever Indonesia, one of Indonesia's largest consumer goods producers. Rosenbluth also noted that Indonesian stocks are diversified, including financial services, telecom and consumer discretionary companies.

Thailand is a growth story as well, Misha said, though she prefers Indonesia. "Indonesis ia better than Thailand in terms of domestic demand and policy reforms," Mishra said. The longtime king of Thailand recently died, and the country has been under military rule for the past few years. "There's signs of challenges there," Madsen said, "but it's still fairly stable."

"The trends are more positive than negative." -Tu Packard, senior economist at Moody's Analytics

Rosenbluth said there is reason to be bullish on Vietnam and look at ETFs like the VanEck Vietnam ETF as part of a basket of Southeast Asian ETFs. But it's a volatile market. There are only 400 stocks on its exchange, and about 80 percent of them are micro-cap stocks, said James Duffy, product manager at VanEck. "So they can be more volatile than developed markets."

Vietnam has a lot of "cowboy capitalism" running through it, in Packard's opinion.

To its advantage, though, Duffy said Vietnam's manufacturing sector competes with China based on its cheaper labor. "So we see it as a potential growth story," he said.

Rosenbluth cautioned investors that Southeast Asian countries are still emerging markets for a reason. Politics can wreak havoc.

Take the Philippines. The economy has been strong. And the iShares MSCI Philippines ETF has done well. But the anti-American policies of new President Rodrigo Duterte can affect investor sentiment. "There are better places to invest," Rosenbluth said. Neither he nor Mishra advise investing there. "The current administration is too unpredictable," Mishra said.

Yet Southeast Asia has a lot going for it. "The trends are more positive than negative," Packard said.

By Constance Gustke, special to CNBC.com