Sunday Morning Coffee

In this week's video I referenced a webinar from IndexUniverse that focused on emerging markets, specifically about allocating to emerging markets in a diversified portfolio. I think the whole thing was about 45 minutes which I felt was worth the time but they also have link to just the PowerPoint instead of Matt Hougan's presentation. I mentioned I wanted to get a little more in depth on emerging market allocation.

A long running theme on this site has been the need for increased portfolio exposure to foreign markets without making too large a bet on any one country and also owning different types of countries; if all you buy are surplus-commodity based countries you are not diversified. At some point that will bite you hard, it would have in 2008.

In the video I said something about 6-8 countries weighted no more than 6% each which gets you up to 36-48% of the portfolio. As a side note 6% would work out to two stocks at 3% each or three stocks at 2% each. I haven't done a lot with country funds but if you would allocate as much as 6% to any single country there would be certain country funds that I think would work for capturing the country that way.

In addition to 6-8 countries weighted above I think there would also need to be several other countries weighted smaller like maybe 2-3%.

Longer term I expect client portfolios might need to get up near 65-70% foreign. For most of this decade I have been in the 30s expecting to get closer to 50% early in the next decade and then maybe 65-70% after that.

A while back one reader asked about going all foreign. First there is a long way between here and 70% but there are several domestic stocks that we own that I think we can hold forever like Johnson & Johnson (JNJ), FPL Group (FPL) and Philip Morris International (PM). I would have included Bank of America (BAC) in that list a year ago but I didn't hesitate to sell it when it did something I thought would be ruinous. I have to think in owning a defense contractor one of the US companies will always be a good bet.

In thinking about countries I would go to 6% in (I am not weighted that heavily in any foreign country now) I would consider Norway, Canada, Australia, China, Switzerland, the UK, Sweden, Chile and Brazil. There might be a couple of others. In the 2-3% category Israel (could be a sixer though), New Zealand (in a few years maybe), Finland, Japan (from the bottom up there are some interesting companies but I don't own any), Taiwan, Singapore, Peru, a couple of Eastern European countries (at some point they will make sense), Morocco, Egypt, Vietnam and there are more.

That obviously is a ton of work but the workload is not the only obstacle. A big one is access. Morocco, well I know the big phone company trades in France which makes it a little easier but getting trades done in European stocks is not necessarily easy. Everyone has heard of Vestas Wind right? Its a biggie in Denmark but trading the ADR just depends on when you come in. Recently the volume has been low, a couple of months ago it was pretty good.

Also for many countries your choices, forget liquidity for a moment, are limited to very few stocks like a phone company, a bank and a few others. Well you can't buy 20 phone stocks and call it a day.

There are country funds but many of them may not be very effective proxies. The Peru ETF (EPU) is probably the best fund for being a narrowly focused proxy for a country. That is not a buy recommendation but the fund is 65% materials for a country that lives and breathes commodities. I also think the Taiwan ETF is a pretty good proxy for tech and again, not a recommendation. EGShares offers emerging market sector ETFs but they are all very heavy in BRIC countries. This will make a lot of sense for a couple of sectors, like maybe energy, but not all.

Another long term tie in is the need to follow many countries and choose them selectively. I've written quite a few posts about Latvia (probably never going to invest there) and Kazakhstan (maybe one day).

Matt Hougan's webinar focuses on thinking about emerging markets differently than we have in the past. I would expand that to all foreign market investing; the need to think about it differently than we have in the past. I might expect comments expressing this would be very difficult. Yes it will be. Others may opine it is unnecessary to do all this. Then those people should not do it.