3 Int’l ETFs With Huge Diversification

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.

2. iShares MSCI Indonesia ETF (EIDO | B-99)

The investable Indonesian economy, as represented by EIDO, looks much more like the Malaysian economy than it does the American economy.

Like EWM, you won’t find any technology exposure in EIDO. Instead, you’ll find pumped-up exposure to the consumer cyclicals and telecommunications sectors. In part, this different sector-composition is what drives the weak correlation (0.28) between EIDO and U.S.-proxy IWV.

Adding a fund like EIDO to your portfolio can help assuage the pain of falling equity markets in the U.S.: During the financial crisis, the Indonesian economy was one of only three (along with China and India) from the G-20 to record growth.

During six-month periods where U.S. equities posted negative returns, EIDO outperformed by an average of 8 percent.

1. iShares MSCI All Peru Capped ETF (EPU | C-33)

Topping the list of best single-country ETFs for diversification is EPU. Peru’s economy looks nothing like America’s: As a resource-rich nation, EPU is heavily dependent on its metals and minerals exports to drive economic growth.

As a portion of the economy, basic materials companies are 15 times more important to the Peruvian economy than they are to the American economy. Said differently, basic materials companies account for roughly half of the investable Peruvian economy, but less than 4 percent of the American economy.

China’s huge growth in consumption of basic materials has pushed up prices and benefited the Peruvian economy. As the world continues to develop and populations continue to expand, the goods the metals and minerals that Peru exports will likely be in great demand.

Peru’s different economic composition helps explain why EPU is almost completely uncorrelated to U.S. equities (correlation coefficient of 0.19).

Not only did EPU outperform U.S. equities by an average of 8 percent during six-month horizons showing negative returns for the U.S., but it actually generated positive performance in 48 percent of the six-month periods where U.S. equities posted negative returns.

At the time this article was written, the author held no positions in the securities mentioned. Contact Spencer Bogart at [email protected].