Invest in Emerging Markets — With UK Stocks: Strategist

Many market strategists have an upbeat outlook for U.S. equities in 2011, but global markets, particularly in developing countries, also may offer upside this year.

British Pound
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British Pound

One way to play it: buy U.K.-listed large cap stocks, says Stephen Freedman, head of investment strategy at UBS Wealth Management Research.

There are two reasons for this, he says: first, U.K. stocks are undervalued, and should rise; and second, a big percentage of earnings for these companies comes from emerging economies, which Freedman believes should outperform developing economies in 2011.

“It’s really emerging markets where you can get economic growth and earnings growth,” he said.

To the first point, the price-to-earnings ratios of U.K.-listed stocks are some of the lowest among developed countries. For instance, the 12-month forward PE ratio for U.K. stocks is 10.4 compared to 13.3 in the U.S., Freedman said.

Adjusting for different mixes of industries among the stocks in each country, U.K. stocks are about 10 percent cheaper than U.S. stocks, he said.

Also, private investors (unlike big institutions) are unlikely to hedge currency risk, and should benefit from appreciation in the U.K. poundversus the U.S. dollar this year. UBS Wealth Management sees the pound—currently about 1.55 versus the dollar—trading below fair market value, Freedman said. The appreciation should provide “some additional lift to returns for U.S.-based investors,” he said.

To the second point, investors can and should invest in emerging markets directly, Freedman said. But as UBS points out in its 2011 Investment Strategy Guide, investors skittish about investing directly in emerging markets can invest in developed market stocks with emerging markets exposure.

Freedman says: “It’s important not to think of U.K equities as a play on the U.K. economy.”

That's because about 70 percent of the earnings of U.K.-listed large caps come from outside from the U.K., according to UBS Wealth Management. Freedman estimates roughly 20 percent of earnings for large-cap, non-financial companies come from emerging markets.

One way for U.S. investors to get exposure to U.K. stocks is through iShares MSCI United Kingdom Index Fund .

The top holdings in the fund include: HSBC Holdings American Depositary Shares,

Vodafone Group ,BP , Royal Dutch Shell and GlaxoSmithKline .

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Disclosure information was not available for Freedman or his company.