Is Decoupling Done?

January 08, 2009

A review of 2008 uncovers reasons to believe that emerging markets will regain their form as a strong diversification tool for U.S. ETF investors. 


It was one of the most tumultuous years in history. Largely as a result of a spreading credit crisis across the globe, investors were hit hard by deteriorating market conditions in 2008.

By year's end, the S&P 500 had a total return of -37%, with the SPDR S&P 500 exchange-traded fund (NYSE: SPY) down a similar amount.

But the storm that ravaged the U.S. markets hit other countries even harder—particularly emerging markets. The MSCI EAFE Index, the most widely tracked benchmark for developed international markets, was down about 45% in 2008.

At the same time, most broad emerging markets ETFs fell in the vicinity of 50%. Results, however, did vary substantially based on region and country.

Performance Overview

The iShares MSCI Emerging Markets Index Fund (NYSEArca: EEM) fell 48.89%, while the Vanguard Emerging Markets Stock ETF (NYSEArca: VWO), which tracks the same index from MSCI, dropped 52.48%. (The underlying index for both lost 54.58%.)

EEM is optimized and VWO is a full-replication fund, which is the likely explanation for the significant performance difference.

Meanwhile, the SPDR S&P Emerging Markets ETF (NYSEArca: GMM) dropped 51.06%, while the PowerShares FTSE RAFI Emerging Markets ETF (NYSEArca: PXH) and WisdomTree Emerging Markets High-Yielding Equities ETF (NYSEArca: DEM) fell 45.28% and 34.56%, respectively.

It should be noted that relative outperformers PXH and DEM are both based on alternatively weighted indexes. 

The four BRIC countries—Brazil, Russia, India and China—had been viewed as the powerhouses of the emerging markets, but they seemed to bear the brunt of world events.

The SPDR S&P BRIC 40 (NYSEArca: BIK) lost 55.54%, while the iShares MSCI BRIC Index Fund (NYSEArca: BKF) slipped 57.32%. The Claymore/BNY BRIC (NYSEArca: EEB) did the best of the three funds, down 54.82%.

Russia, which saw quite a bit of its own turmoil in 2008, was perhaps the most distressed of the four markets. The Market Vectors Russia ETF (NYSEArca: RSX) fell a rather breathtaking 73.61% during the year. In addition to dragging down the BRIC indexes, it looks like difficulties in Russia may have contributed to the under-performance of Eastern Europe in general. MSCI's EM Eastern Europe Index sank nearly 70% for the year.

(An interesting side note is that although there are currently no funds covering the region as a whole, Barclays Global Investors has filed to add just such an ETF to its iShares lineup.)

India also performed quite poorly, though not as badly as Russia. The exchange-traded note tracking the MSCI India Index, the iPath MSCI India ETN (NYSEArca: INP), fell 67.64% in 2008. 

Meanwhile, the funds covering China and Brazil did much better, with the iShares FTSE/Xinhua China 25 Index Fund (NYSE Arca: FXI) and SPDR S&P China ETF (NYSEArca: GXC) down 47.77% and 49.63%, respectively. The iShares MSCI Brazil Index Fund (NYSEArca: EWZ) fell 54.64%.

A Regional Breakdown

Viewed from a regional perspective, performance varied to a significant extent. Eastern Europe, in particular, was hit very hard, no doubt in part due to Russia's disastrous performance and its rather dramatic problems in 2008, not the least of which was the invasion of Georgia. The SPDR S&P Emerging Europe ETF (NYSEArca: GUR) lost 65.66%.

But it's important to note that Russia represents more than half of GUR's portfolio. Four others—Poland, Turkey, the Czech Republic and Hungary—each represent anywhere from 5% to 15% of the fund's holdings.

According to MSCI, South Africa's market dropped around 40%, while Israel fell just about 31%. Meanwhile, the MSCI Frontier Markets Africa Index lost roughly 56%, and the MSCI Emerging & Frontier Markets Index dipped about 46%.

Latin America showed "moderately bad" performance, with iShares S&P Latin America 40 Index Fund (NYSEArca: ILF) down 47.38% and the SPDR S&P Emerging Latin America ETF (NYSEArca: GML) down nearly 51%. The MSCI Emerging Latin America Index was down 52.78%, but there was a wide degree of variation in performance. While Brazil was down roughly 58%, MSCI's Chile and Colombia indexes were down about 37% and 27%, respectively—the iShares MSCI Chile Investable Market Index Fund (NYSEArca: ECH) was among the best-performing single-country emerging market ETFs, with a decline of 37.64%.

Asia's performance was similarly poor, with the SPDR S&P Emerging Asia ETF (NYSEArca: GMF) down 49.58%—keep in mind that the fund's portfolio includes both China (39% of the portfolio) and India (18%). The MSCI Emerging Markets Asia Index dropped roughly 54%.

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