Investment Insights

Jeff Benjamin

How to ‘backdoor’ emerging markets in 2011

By focusing on specific themes and countries, investors can boost returns, reduce risk

Jan 4, 2011 @ 9:01 am

By Jeff Benjamin

Emerging markets remain red-hot among investors, but rather than just making a broad sector bet, advisers should look for specific and strategic exposure to these economies as a way to minimize risk and take advantage of sweet deals.

For example, instead of allocating a portion of a client’s portfolio to a general index like the iShares MSCI Emerging Markets Index Ticker:(EEM), advisers can follow the lead of professional money managers and market analysts by focusing on precise drivers within the respective economies.

Infrastructure is one such driver.

India’s commitment to spend $250 billion over the next five years to upgrade the nation’s power generation network is an example of the kind of infrastructure development in the works in these fast-growing economies.

“Where else will you get that kind of capital outlay?” asks Paul Atwood, a portfolio manager at Huntington Asset Advisors, which manages $13 billion. “The government might even be underestimating what it will need to spend, and I don’t see that [infrastructure build-out pattern] disappearing.”

Like many emerging-markets investors, Mr. Atwood is focused on the general trend of consumers entering the middle class and migrating to more-urban areas. An investment strategy that taps into the growth of that middle class can be part the larger theme of building infrastructure.

“You could make the case that when we own a bank in India, we are exposed to that infrastructure play,” he said.

Infrastructure development is an investment theme that can be applied to virtually any emerging economy. In India, 80% of the roads are still just two lanes are less.

In China, where more than 15 million people a year are moving to urban areas, the goal is to build 97 new airports and to renovate 147 existing airports by 2020.

In Brazil, where only 6% of the roads are currently paved, money managers are anticipating a ramping up of infrastructure development as the country prepares to host the 2014 World Cup soccer tournament and the 2016 Summer Olympics.

Russia, an energy-rich emerging market, will be building its infrastructure as it prepares to host the 2014 Winter Olympics and the 2018 World Cup.

Combined, it’s estimated that more than $6 trillion will be spent on infrastructure development across all emerging markets over the next three years.

In terms of specific targets, Joshua Duitz, manager of the Alpine Global Infrastructure Fund Ticker:(AIFRX), likes China Mobile Ltd. Ticker:(CHL) and Brazilian water company Companhia de Saneamento Basico Ticker:(SBS).

Alpine Funds, which manages $7 billion, launched the global infrastructure fund in September 2008 to tap into the trend.

Mr. Duitz, who invests primarily through the local exchanges, said it is no longer efficient just to invest for broad country or market exposure.

“In a country like China, the valuations for rail companies is not there anymore but port and water companies are still cheap,” he said. “You can still find opportunities, but you need to spend more time looking.”

There are also some overlooked “back doors” into many of the emerging economies, according to Charles Sizemore, owner of Sizemore Capital Management LLC, a boutique research and investment firm.

While Mr. Sizemore is not a fan of China because of its fuzzy economic data, or Russia “because they tend to throw business executives in jail,” he does believe in tapping some markets from a safe distance.

Telefonica SA (TEF), a telephone services company based in Spain with a price-to-earnings ratio of 7, is deriving 60% of its revenue from European and Latin American emerging markets.

“This is a company that has been left for dead just because it’s based in Spain,” Mr. Sizemore said. “It’s truly absurd; you don’t normally see these kinds of bargains after an emerging-markets rally.”

Another example is Unilever PLC (UL), a 100-year-old blue chip, which is paying a 4% dividend and drawing half its revenue from emerging markets.

In keeping with the emerging-middle-class theme, Mr. Sizemore recommends EGShares Emerging Markets Consumer (ECON), an exchange-traded fund made up of companies that sell to emerging-market consumers.

“That’s an ETF for somebody who wants some real buy-and-hold emerging-markets exposure,” he said.

Mr. Atwood, though, reminds us of a caveat.

“One concern about the emerging markets right now is that everybody loves them, but people need to remember that they do have volatility and risk,” he said.

Questions, observations, stock tips? E-mail Jeff Benjamin@investmentnews.com.

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