Exchange Traded Funds

The U.S. sneezes, the rest of the world catches a cold, goes an old saying. Recent events suggest the opposite: the U.S. has the cold while the world is merely sneezing. One year after the Lehman Brothers collapse, emerging markets ETFs have moved decisively higher while mature economies of the U.S. and Europe are still struggling.

This is seen in a comparison of Vanguard Emerging Markets ETF (NYSE:VWO), and the iShares MSCI Markets Index (NYSEArca:EEM), and the U.S. equity benchmark Standard and Poors Depositary Receipts (NYSEArca:SPY).

Emerging markets ETFs EEM and VWO fell farther than the SPY in November and December 2008 but pulled even with the SPY at the March 2009 nadir. Since then, emerging market ETFs have sharply outperformed, undoing value lost in the worst months of the credit crunch, and more.

Historically, investors have turned to emerging markets for higher returns and to lower portfolio volatility. Performance of far-away markets was thought to be covariant with domestic performance. But in the last few years, investors found emerging markets funds to be increasingly correlated with domestic equities. Emerging market exposure became about gearing: another way of adding to portfolio beta.

But the worry and risk of investing in emerging markets was always that during a severe downturn in the West, the West would export crisis. There are two main reasons for this fear. First, emerging market economies are dependent on U.S. and Europe for exports. When western economies falter, emerging economies suffer a reduction in exports and have no domestic demand to substitute. Second, the West has historically provided capital. A downturn in the West is typically followed by reduced bank loans to emerging market countries and liquidity shocks. During a crisis, emerging market economies are unable to replace lost liquidity locally or through the IMF at a low cost. The result is that credit gets very expensive or dries up. The economic collapse is steep and trenchant.

Or is it? This time, investors in emerging markets seem to have alpha, albeit on higher volatility. This sample size is too small to make any definitive determination. The chart above begs the question: why are emerging market ETFs outperforming during a serious downturn?

Trouble in the West is unquestionably serious for emerging market countries. Declines in imports are felt immediately. But these economies are arguably de-coupling, starting to grow their own internal demand and are not as susceptible as they were. Demographic advantages and high growth rates hasten this demand. Money flows increasingly are moving from emerging economies to the West. There may also be less obvious explanations. A more globalized banking sector may also transmit monetary intervention born in New York and London to the capital markets of emerging economies. If this is happening its a good deal for investors in emerging market funds. They get the benefit of global monetary coordination in a severe downturn and all the growth of the emerging economies in better times.

One final point: emerging market ETFs are valued in the local currency. An important factors in their performance is the exchange rate against the dollar of the local currency in which those assets are dominated. A strong dollar will buy more foreign assets, so in periods of dollar strength emerging market funds tend to suffer. By contrast, dollar weakness is good for the performance of emerging markets ETFs, particularly if the funds holdings serve the domestic market and thus are more isolated from the potential for falling demand for a region’s exports.

The ETF family includes an impressive number of funds focused on emerging market economies. In addition to the broadly focused regional and super-regional emerging market ETFs like EEM and VWO, there are ETFs dedicated to specific countries, from South Africa to Malaysia to Chile. The list below includes some of the most influential and largest emerging markets ETFs and their expense ratios:

GENERAL EMERGING MARKET ETFS

iShares MSCI Emerging Markets Index Fund (NYSEArca:EEM), 0.72%

Vanguard Emerging Markets ETF (NYSEArca:VWO), 0.20%

SPDR S&P Emerging Markets ETF (NYSEArca:GMM), 0.59%

BLDRS Emerging MKTS 50 ADR Index Fund (NasdaqGM:ADRE), 0.16%

PowerShares FTSE RAFI Emerging Markets Portfolio (NYSEArca:PXH), 0.85%

WisdomTree Emerging Markets High-Yielding Fund (NYSEArca:DEM), 0.63%

BRIC ETFS

streetTRACKS SPDR S&P BRIC (Brazil, Russia, India, China) 40 ETF (NYSEArca:BIK), 0.40%

Claymore/BNY BRIC (Brazil, Russia, India, China) ETF (NYSEArca:EEB), 0.60%

REGIONAL ETFS

SPDR S&P Emerging Middle East & Africa ETF (AMEX:GAF), 0.59%

SPDR S&P Emerging Europe ETF (NYSEArca:GUR), 0.60%

SPDR S&P Emerging Latin America ETF (NYSEArca:GML), 0.60%

iShares S&P Latin America 40 Index Fund (NYSEArca:ILF), 0.50%

FRONTIER ETFS

Van Eck Market Vectors Africa Index ETF (NYSEArca:AFK), 0.83%

Claymore/BNY Mellon Frontier Markets ETF (NYSEArca:FRN), 0.65%

SPECIALTY EMERGING MARKETS

PowerShares Emerging Markets Infrastructure (NYSEArca:PXR), 0.75%

PowerShares DWA Emerging Markets Technical Leaders (NYSEArca:PIE), 0.90%

SPDR S&P Emerging Markets Small Cap (NYSEArca:EWX), 0.76%

WisdomTree Emerging Makets Small Cap Dividend (NYSEArca:DGS), 0.63%

WisdomTree Dreyfus Emerging Currency Fund (NYSEArca:CEW)

SHORT AND LEVERAGE

ProShares Short MSCI Emerging Markets ETF (NYSEArca:EUM), 0.95%

ProShares UltraShort MSCI Emerging Markets ETF (NYSEArca:EEV), 0.95%