I love discovering alpha in the stock market. Alpha, in this context, means excess returns relative to the return of a passive index fund over the same time period.
Alpha is the goal of every investor regardless of size, from the largest hedge funds to everyday investors. Sometimes, it takes looking outside of your comfort zone to find alpha. And right now, the emerging markets are where it's at.
Emerging markets have soared over 17% this year. This is nearly 300% higher performance than the 6% or so year-to-date return of the S&P 500.
How Do I Invest In Emerging Markets?
Don't worry, it's easy! Today's stock market investors can capture emerging markets alpha via ETFs. Once reserved for wealthy and connected investors, ETFs are now available for every investor.
Investing in ETFs is no different than buying any stock. ETFs provide ready-built diversification, liquidity, and access to a wide variety of markets.
There are genuinely diversified ETFs holding a basket of stocks across the emerging markets, and there are others that are nation- or even industry-specific.
3 Ways To Play Emerging Markets
India is my favorite emerging market right now. The once-struggling economy has gained significant footing and is currently the world's seventh-largest.
Over the last half decade, the India MSCI Index has soared 70%, and the economy is only getting better. In fact, reforms and political changes mean that now is the perfect time to invest in India.
Second, India recently launched a social security program covering 99% of all Indian adults. The added financial security will lead to greater investment and a long-term uptick in consumer spending.
Next, the removal of large-denomination paper currency from the economy has helped control the rampant black market. Removing large notes from circulation also has the side effect of formalizing savings for scores of citizens.
Finally, the successful rollout of high-speed internet across the nation will work to supercharge consumer spending.
The smartest way for an individual investor to play the Indian economic boom is via the iShares MSCI India ETF (NYSE: INDA). The ETF is up over 19% in 2017 and provides investors exposure to large and midsized Indian companies.
Entering stocks on a pullback is a time-proven method of creating long-term alpha in your portfolio.
Russia is my second-favorite emerging market. Although it has underperformed recently, now is an ideal time to invest in the changing economy.
Russia's internal economic improvements show a sincere interest in supporting business growth. The Putin administration is focused on a convertible currency, infrastructure enhancements, and transportation advancements, including a railroad to the North Korean seaport of Rason.
What has me most excited is the encouragement of foreign investment in the once-closed nation. Inflows of outside capital have the potential of supercharging the Russian stock market.
Investors can access the Russian equity market via the iShares MSCI Russia Capped ETF (NYSE: ERUS). Lower by over 7% this year, ERUS has significant rebound potential in the long term.
3. All Emerging Markets
Political risk is a very real factor in emerging economies. The best way to mitigate political risk is by diversifying across a spectrum of emerging markets. While this sounds difficult and time-consuming, a plethora of ETFs make it as easy as buying a share of stock.
I like the Goldman Sachs ActiveBeta Emerging Markets Equity ETF (NYSE: GEM) to gain diversified exposure to the emerging markets sector. The ETF is higher by nearly 15% this year and allows widespread diversification.
The fund is spread out over Asia, Europe, the Middle East, Africa, and Latin America. Asia boasts the heaviest weighting with over 70%, Africa, Middle East, and Europe are next with a 15% allocation, and Latin America takes up the slack with a little more than 13%. The remainder is held in cash for deployment when opportunities arise.
Managing over 370 different stocks, GEM is overseen by a quantitative team of 100 analysts and portfolio managers. Stocks are chosen by applying four attributes of performance: good value, strong momentum, high quality, and low volatility.
Risks To Consider: Make no mistake, emerging markets are precarious. A combination of economic and political risk gives emerging markets an extra layer of risk not readily found in established economies. It is important to diversify and size positions properly when investing in emerging markets.
Action To Take: Consider diversifying your portfolio into the emerging markets using one of the ETFs described above.
Editor's Note: Investing in energy storage more than doubled in the first quarter 2016. Indicators point to an upward track for this breakout industry. Here are three ways to play it for 10 times the gains by 2020. Full story here.