Investors focusing their attentions in emerging markets often look towards the faster developing regions of Asia and Latin America for portfolio growth. After all, their huge populations, newfound wealth and increasing public- and private-sector spending are helping to support sustained GDP growth. Broad index measures like the Vanguard MSCI Emerging Markets ETF (ARCA:VWO) often include heavy weightings to the two territories. However, just as important to portfolios is exposure to Eastern and Central Europe. Cast in the same light as their developed market neighbors, the region is often ignored and underweighted in many portfolios. For investors, this could lead to a variety of opportunities for long-term growth. (For related reading, see The Risks Of Investing In Emerging Markets.)
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As developed Europe continues to grapple with its debt crisis, emerging Europe continues to press on and that could spell real opportunity for investors. Foreign direct investment (FDI) continues to increase in the region as many global manufacturers have begun to invest in new facilities and factories. Taxes and wages are relatively low compared to the rest of developed Europe, and the availability of skilled workers is high. The Czech Republic, for example, represents one of the large machinery markets within the EU27 as measured in Machinery output per GDP. The nation is only surpassed by Germany and Finland. China has certainly seen the FDI potential and has begun investing in roads, power plants and electronics manufacturing across Poland, Serbia and Bulgaria. Analysts at Price Waterhouse Coopers estimate that FDI in emerging Europe will reach around US$172 billion by 2014.
Additionally, higher commodity prices are helping many of the nations within the expanse. Russia is benefiting from continued high oil prices and its abundance of coking coal and iron ore. Kazakhstan is set to double its oil production in 2012 and the Ukraine's black earth region is some of the richest agricultural soil on the planet. These richest in natural resources will ultimately help developing Europe achieve similar consumer and GDP gains as their Latin American and Asian sisters. (For additional information, see The Importance Of Inflation And GDP.)
Finally, Eastern Europe remains relatively free from the debt yoke holding back the rest of the Eurozone. Its young population remains very under-leveraged, with mortgage-to-GDP rates far below the continent average. Turkey currently sits at a mortgage debt-to-GDP rate of 4%. More "developed" Eastern European countries such as Poland, are around 20%. Inflation across emerging Europe remains low and the Hungarian government has recently begun moves to ease the burden on mortgage owners within the country.
With the region often missing from portfolios, investors should consider beefing up their allocations to developing Europe. The iShares MSCI EM Eastern Europe (ARCA:ESR) and SPDR S&P Emerging Europe (ARCA:GUR) are currently the only broad plays for the nations. Both are Russian-heavy with top holdings in Mobile Telesystems (NYSE:MBT) and Gazprom (OTCBB:OGZPY). Remaining weights are spread among the Czech Republic, Poland and Hungary. The two exchange traded funds (ETFs) can provide the basis for investment in the region.
With its historical ties to developed Europe, some analysts are worried about any near-term complications from the Eurozone's debt hangover. To that end, investors may want more of a "safety net" for their investments. The closed-ended Central Europe & Russia Fund (NYSE:CEE) currently trades for around a 10% discount to net asset value (NAV) and features many of same companies held by the previously listed ETFs. In addition, the Morgan Stanley Eastern Europe Fund (NYSE:RNE) trades at approximately an 11% discount and provides more exposure to non-Russian firms. (To learn more, read 5 Common Misconceptions About ETFs.)
Finally, investors may want to bet on the two leading consumer stories in emerging Europe. Both Poland and Turkey have benefited from thriving manufacturing bases as well as increases in domestic spending. The Market Vectors Poland ETF (ARCA:PLND) and iShares MSCI Turkey Index (ARCA:TUR) can provide broad plays on their respective economies, while telecom Turkcell (NYSE:TKC) and spirit distributor Central European Distribution (Nasdaq:CEDC) can be used to tap into their consumer stories.
The Bottom Line
Eastern and developing Europe continue to be ignored by many investors. However, the region is just as important to portfolios as emerging Asia and Latin America. By beefing up allocations to region, portfolios can prosper from its rising consumer stories and rich abundance of natural resources. The previous examples, along with the Market Vectors Russia ETF (NYSE:RSX), make ideal choices. (For related reading, see The Benefits Of ETF Investing.)
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At the time of writing, Aaron Levitt did not own shares in any of the companies mentioned in this article.