If you look hard enough, you can find single-country equity ETFs that don’t look and act at all like U.S. stocks.
Diversification is more valuable than ever: Thanks to globalization, economies around the world are more synced with each other than they once were. With that in mind, I’ve identified three emerging markets with tremendous diversification power.
I found these countries by evaluating single-country ETFs whose returns weren’t strongly correlated to returns in the U.S. and whose economies comprise different industries than those that drive the American economy.
I looked at returns for a cluster of rolling six-month periods for each of the ETFs that extended from launch date of each security to Friday, Sept. 12. Based on this approach, the three single-country ETFs below offer the greatest diversification potential—in ascending order—relative to the U.S. benchmark the iShares Russell 3000 ETF (IWV | A-100).
3. iShares MSCI Malaysia ETF (EWM | B-97)
The Malaysian economy is very different from the American economy, and that partly explains why equity returns in the country are on a completely different track than American equity returns. In fact, with a coefficient of 0.33, the correlation between equity returns in the two countries is very weak, to say the least.
As represented by the iShares Russell 3000 ETF (IWV | A-100), sectors such as telecoms and utilities only comprise some 5 percent of the American economy. In contrast, these highly defensive sectors amount to more than 20 percent of the investable Malaysian economy—as represented by EWM.
The differences don’t stop there: Home to many of the world’s largest technology companies, it’s no surprise that information technology is the second-largest sector in the United States. While this sector is crucial to the American economy, it’s completely nonexistent in EWM. That means that when U.S. tech investors reel during a weak-earnings swoon, Malaysian investors mightn’t be impacted at all.
Moreover, while the U.S. economy generally suffers from rising energy prices, Malaysia actually benefits because it is an exporter of oil and natural gas.
This diversification benefit is evident in evaluating rolling six-month returns for Malaysia-proxy EWM and U.S.-proxy IWV. In six-month horizons where IWV had a negative total return (American equities were down), EWM outperformed by an average of 6.3 percent.
