Four Ways to Play Emerging Markets: It's Not Just Stocks

Emerging markets still will provide value to investors—but not necessarily through their stock markets, strategists at Barclays Wealth Management said Wednesday.

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China Traders

Market pros have been generally supportive of the emerging market theme this year, based in part on the notion that countries such as India, Brazil, Indonesia and China will grow faster than the comparatively modest pace in the United States and other developed economies.

But that doesn't necessarily mean stocks there will be more attractive. Emerging market stocks grew about 40 percent in 2009, doubling the US stock markets. That has prompted fears that overseas markets could be ready to slow down.

"Being bullish on emerging markets growth does not automatically translate into being bullish on growth of emerging markets equities," Aaron Gurwitz, head of global investment strategy for Barclays, said at the firm's quarterly outlook briefing.

Broadly speaking, emerging markets have gained about 3.1 percent in 2010 as measured by the benchmark iShares MSCI Emerging Markets Index exchange-traded fund. By contrast, the Standard & Poor's 500 is up 6.7 percent year-to-date.

Barclays remains overweight in its allocation to emerging markets, but says there are better ways to gain exposure than through simple stock investing.

"We want the emerging market flavor to pervade the overall portfolio and not necessarily favor emerging market equities," Gurwitz said.

The firm, which manages $240 billion in assets as the wealth management division of its investment bank parent, breaks its strategy into four main parts.

1. Currencies

The currency strategy is part of an overall approach to diversification to avoid any major pratfalls should individual problems pop up in the developing economies.

Barclays favors of mix of undervalued currencies from Russia, Korea, Mexico, India, South Africa, Taiwan, China and Brazil.

Diversification is important as global governments manage their way into prosperity now that post-credit-crisis armageddon scenarios have past.

"Governments working together...actually saved the world," Gurwitz said. "Now that they don't have a gun to their head, we're less sure that they will get the public policy challenges right."

The best way to buy foreign currencies is through a broker, a web site specializing in such transactions or an Exchanged Traded Fund.

2. Country ETFs

The diversity theme stays intact when it comes to using ETFs, which are generally passively managed and tied to stock indexes, to play the emerging market growth theme.

Rather than being tied to the broad emerging market ETFs, Barclays suggests having exposure to individual countries through an ETF fund that invests only in local stock indexes.

One factor in favor of emerging markets is a likely reluctance among policy makers to enact policies aimed at guarding against inflation and thus putting the brakes on growth.

"No major central bank seems ready to raise your rates," said Kevin Gardiner, head of investment strategy in Europe, the Middle East and Africa. "Even though they have rallied so much, global markets to us don't look expensive."

Country EFTs can be bought as easily as individual stocks through an online broker or exchange.

3. Commodities

As emerging economies grow they will continue to need raw materials to fuel the expansion of the global middle class. That means continued moves higher in oil and virtually anything else used in the construction needed to build bustling new cities.

Barclays recommends more diversity, this time along a wide basket of commodities mostly traded in US dollars.

Brazil Stock Exchange
Andy Caulfield | Stone | Getty Images
Brazil Stock Exchange

The attraction to commodities fits in not only with an emerging markets theme but also a belief that the world economy will continue to grow.

"We think that there is a recovery out there," Gardiner said. "We think it will continue so we're pretty positive on risk assets."

Commodities can be bought as a futures contract through a broker or in an ETF.

4. Stocks, Too

While emphasizing multiple strategies, Barclays experts emphasized that the firm is not dumping emerging market equities but rather looking for stronger areas of growth.

US companies, such as in the semiconductor and resource industries, that do a lot of business with developing economies are good places to look, said Manpreet Gill, head of Asia investment strategy.

The strategy is part of what the company calls its Asia Fusion portfolio.

More broadly speaking, Barclays broke its strategy into two cases: The more likely scenario of fairly slow but sustained growth, and what it deemed its "second most-likely scenario" where growth, particularly in the US, slows dramatically after government stimulus wears off.

"If at that point the private sector is not ready, willing or able to carry on its way, we could have another period of slower growth or perhaps a double-dip," Gurwitz said. "We could have for us a fairly serious problem because we won't have any ammunition left.

"In that case, investors should protect themselves against deflation by using longer-duration fixed income, primarily corporate bonds, and government debt.