We decided to name the recent equity volatility after the amount and ferocity of the snow storms that continue to hit a significant part of the country. The storms that were in the West, East and Midwest have even hit the South and the equity weakness that was largely in Emerging Markets and select Asian Countries has even hit the US markets that seemed until recently, untouchable.

Will the storms that continue to make life miserable for much of the East and Midwest continue and will the equity market down drafts paralyze investors?  We here at Zenith hope for some reprieve for all places except for the mountain regions where a foot of snow is welcome.

As we mentioned in one of our latest blogs, the structural imbalances in some Emerging Countries will likely lead to more volatility in spite of reasonable positive growth here in the U.S.  We would like to take a look at a few areas of the Asian region represented by passive ETFs and then present an active fund to compare volatility in this short time period.

I-Shares MSCI All Country Asia Ex Japan (AAXJ) -8.03% This ETF has holdings to varying degrees in all of the countries listed below. The largest holdings are as follows; China 26%, South Korea 20%, Taiwan 15%, Hong Kong 12%. The rest of the countries are below 10%.

These are individual country ETFs created by Blackrock I-Shares.

I-Shares MSCI Honk Kong (EWH)  YTD -7.43%

I-Shares MSCI Singapore (EWS) YTD -7.74%

I-Shares MSCI Korea (EWI) YTD-10.45%

I-Shares MSCI Taiwan (EWT) YTD – 6.73%

I-Shares FTSE China 25 (FXI) YTD-11.02%

I-Shares MSCI  India (INDA) YTD-5.53%

I-Shares MSCI Indonesia (EIDO) YTD+2.5%

I-Shares MSCI Malaysia (EWM) YTD-6.64%

I-Shares MSCI Thailand (THD) YTD-2.65%

Generally speaking if at the end of 2013 an investor wanted to gain exposure to this area of this area of the world they could have taken one of three major approaches. An equal weight approach to the nine country specific ETFs above would have returned approximately negative 6.17% while the All Country ETF described above lost approximately -8.03%. This is largely due to the overweight positions in China and South Korea in AAXJ.

While there are many other items to consider, the main issue with the all-country Asia ETF approach is that the investor is hamstrung by the current weights of country exposure which may or may not work well. The second approach is more flexible but will ultimately incur more trading which takes up valuable time. In addition, the countries listed in this piece have reasonably disparate growth and risk profiles.  A manager might be able to understand and to mitigate the risks in this region as well to identify the best growth prospects.

An investment  in Aberdeen Asia Ex-Japan (AAPEX) has returned negative 6.20% YTD. That is not too impressive as active managers garner the high fees to reduce risk in times of stress in the system. They are supposed to over and under weight countries and sectors that prospectively add value and reduce risk.

The active manager saved the investor close to 180 basis points in losses compared to AAXJ but charges over 1% for this ability. They were close with the individual country specific ETF approach but a fee and turnover analysis would need to be done before you sent this to your trading desk. The question for your investment committee is whether or not this or any other fund in this very specific segment of the equity market can over longer periods of time, add consistent value above broad-based Exchange Traded Funds.

Another more subtle question is whether or not it makes sense to invest into each sliced up area of the equity markets. The Asia-Pacific region offers a lot of opportunity but is defining it by this particular index the correct way to go, or would it make more sense to find a global manager that seeks value in many regions including this one but is not tethered by a specific regional mandate.

We believe that placements in funds in these specific segments must take valuation and volatility into consideration as well as a process examination so you understand if your placement with a manager is simply expensive beta or if it could truly mitigate risks in turbulent times.

We covered briefly a very specific area of the equity world with a snapshot in time of only a little over a month for the returns.  We suggest that you examine the valuations and growth prospects that your funds possess and to look back a variety of time periods to determine if value was created.

With an unending stream of new funds and ETFs being created seemingly weekly, it can be overwhelming. Sadly a lot of these products created to mirror an index of any kind are not materially solid investments and are typically not vetted to the degree they need to be examined.

As your firm reviews its current or prospective placements in non-US markets such as this, we suggest you develop a robust process for equity fund or ETF inclusion.


Tom Koehler, CIO

“Equity markets represent a complex asset class and while we covered a very small amount, there is a lot more information needed prior to making an investment decision. Let us know if we can provide more information to help in that process.”