Asia Pacific ETFs: Starter Kit for Would-be Portfolio Managers

By Katrina Lamb | May 24, 2007 AAA

China and India get most of the headlines, but there are other good stories in the Asia Pacific Region. Among Morgan Stanley Capital International's (MSCI) country indexes, this year's No.2 performer is Malaysia (32.25% YTD total return as of May 18) with the Philippines and Singapore not too far behind at 22.14% and 20.92% respectively. The region's stock markets have done quite well in the past several years as have the underlying economies. There are structural factors in place that continue to bode well here.

Broad country exposures are relatively easy to obtain via exchange traded funds (ETFs). The Barclays MSCI iShare series includes single-country ETFs for Malaysia (NYSE: EWM), Singapore (NYSE: EWS) and Hong Kong (NYSE: EWH) among others. Another ETF called the FTSE/Xinhua China 25 (NYSE: FXI) gets direct mainland China exposure. ETFs are a good way to take passive country exposure while mitigating the risks of active stock picking. The variety of Asia Pacific ETFs also lends itself to strategies that can bring out our inner portfolio managers.

The ABCs of APR
What exactly is the Asia Pacific Region? It is a diverse part of the world with distinct economic propositions. China is the world's fourth-largest economy by nominal GDP (second by purchasing power parity). India is the miracle of the global service economy. These two are in a class of importance by themselves and make up the "IC of BRIC" along with Brazil and Russia.

In the heart of Southeast Asia are: Malaysia, Singapore, Indonesia and the Philippines. Although linked in many ways these economies are in fact quite distinct. Singapore (and to some observers Malaysia) is considered to have reached "developed-market status" while Indonesia and the Philippines are more solidly emerging. Then there is the "Pacific Basin" moniker which usually adds Australia and New Zealand to the Asian countries.

Of Palm Oil and Palm Pilots
Once upon a time the region was known mostly for exports such as palm oil, exotic spices and tea. It has since gone through iterations of the outsourcing revolution from cheap electronics manufacturing in the 1970s and 1980s to telemarketing in the 1990s and the increasingly sophisticated integrated services centers of today. More than merely supplying the world with coffee and customer service reps, though, the distinctive feature of APR today is the demand-side explosion from prosperous, sophisticated and spend-happy consumer markets.

Although very much a part of the global economy, the region is increasingly self-sufficient, with a full value chain of products and services to sell to its own inhabitants as well as those of traditional export markets in North America and Europe. This is a structural rather than a cyclical trend, and, in my opinion, a key reason for long-term market upside.

Markowitz Goes to Asia
Portfolio management theory involves the holy trinity of return, risk and correlation. In the chart below we see an interesting risk-return relationship between different APR markets, represented either by the representative iShares ETFs or, in the case of India (NYSE: INP), the actual MSCI index. For comparison purposes we have included the S&P 500 and two other U.S. indexes, the Nasdaq Composite and the Russell 2000 Small Cap Growth Index.

rra.gif




correlation - comes into play. What moves India doesn't necessarily move Malaysia in the same way. In fact, the R-squared - a statistical measure of correlation – between India and Malaysia was 0.35 for the time period shown in the above chart (1.0 being maximum positive correlation). Low correlation equals positive portfolio value.

Conclusions
We tend to think of ETFs simply as passive indexed vehicles. Increasingly, though, there are ways to make intelligent use of the return, risk and correlation properties of different ETFs to act on a strategic view, such as being long-term bullish on Asia Pacific. This makes good investing sense, and for the portfolio management geeks among us, it's just plain fun.

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