What You Really Own In Foreign Funds

James Juliano Insights

“Emerging markets” is not a coherent investment theme, rather it is an investment industry shortcut based on sloppy thinking. Any emerging market index is composed of many vastly different countries that are governed by dramatically different sets of government economic policy. We applaud Muhammed El Erian, one of the most successful investors of our time, for joining us and others who have long been blowing the whistle on emerging markets as an investable asset class.

Rethinking Emerging Markets by Mohammed El-Erian

One powerfully simple way to properly divide emerging market countries is to break them into those countries helped and hurt by a strong US$. When doing so to the most commonly used emerging market vehicles, BRIC funds (Brazil, Russia, India and China), we find the group is spilt into two. Brazil and Russia are heavily tied to commodity prices and crushed when the US$ is strong. In contrast, China and India are not harmed by a strong US$ and, in fact, benefit from one. Even China and India, though they have similar features when tied to US$ strength or weakness, should not be considered the same asset class. Investors should only commit capital to a country based on the merits of its individual economic policy environment. Grouping any of the emerging markets together puts investors at risk of not doing the one thing all investors must effectively do to build and protect wealth – know what you really own and why you own it.

Owning a group of emerging markets does, however, give investors exposure to some commonalities. The sobriquet emerging markets generally means that many things are missing, like democracy, rule of law and sanctity of contracts. The lack of these institutional foundations makes it even more crucial for investors to know if the economic policies affecting each country are good or bad. Let’s examine what country and policy bets investors are actually making when owning emerging market funds.

One of the largest and most popular emerging market investment vehicles is the iShares MSCI Emerging Markets ETF. Digging in we find that this fund has the following country exposure: China 23%, South Korea 15%, Taiwan 13%, South Africa 8%, Brazil 8%, India 7%, Mexico 5%, Russia 4%, Malaysia 4%, Indonesia 3%, Thailand 2%, Turkey 1%.

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We recategorized these countries into three buckets: red, yellow and green zones.

  • Red zone countries have poor economic policy landscapes confirmed by poor “Footprints” in their equity markets.
  • Yellow zone countries have neutral economic policies confirmed by transitioning “Footprints” in their equity markets.
  • Green zone countries have positive or improving economic policies confirmed by positive “Footprints” in their equity markets.


We find that only 52% of the emerging market countries in the ETF are in the green zone, 5% are in a transitional yellow zone and 39% dangerously fall into a red zone.  Investors who commit capital to this broad emerging market vehicle are really making a near 50% bet on countries with poor or deteriorating government economic policies and weak equity markets.

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Looking at the investment performance since 2012 of individual red zone versus green zone countries reveals the reality of investing in red zone assets.

In the green zone, the worst performing country has gained 25%, several have gained near 50% and the best performer has advanced 85%.

In the red zone, the best performing country has gained 20%, several have gained between 5-10% and the three worst performers have lost 30-40%.

Again, know what you own and why you own it. Since 90% of investment return is determined by asset allocation, it is not prudent to allocate assets into industry fabrications that mislead investors. We believe in proactive asset allocation by committing capital to good and improving policy locations while avoiding poor and deteriorating policy locations. In the world of emerging markets, doing so has and will continue to make a huge difference.

Historical Performance of Current Green Zone Countries

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Historical Performance of Current Red Zone Countries

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