10 Best ETFs for Decoupling 2.0

When in 2007 it became clear the recession in the rich word was inevitable, many economic commentators predicted that major emerging markets would “decouple” from their export markets and continue growing on the backs of increased domestic demand. By 2008 it was clear that decoupling wasn’t going as planned as exports, industrial production, output, and share prices collapsed all across the emerging world. The very idea of decoupling was thereafter ridiculed as a hypothesis proven wrong.

In the end, however, it may merely be seen as a prediction proven early. In 2009 emerging markets are clearly on their way to recovering faster than developed ones. Emerging sharemarkets are up spectacularly YTD. Output is expected to be above 5% in both China and India this year, and positive for most emerging economies by 2010.pic453

This phenomenon has been coined “Decoupling 2.0″ by The Economist. This new version of the decoupling thesis sees growth powering forward in big emerging economies such as China, India, and Brazil that have room to expand domestic demand and increase trade amongst themselves. It won’t happen everywhere. Mexico is too dependant upon the US. Emerging Europe is too indebted and too tied to the Eurozone. But most emerging economies will find a way to grow in the next few years even while America and Europe are mired in recession or stagnation.

Emerging markets aren’t only recovering earlier than their developed peers, but they are also recovering differently. Developed markets are likely to return to growth when consumer spending recovers. Emerging markets are driven more by investment spending, in both the government and private sectors. China’s stimulus programs are set to add to China’s already considerable infrastructure. And the Congress party’s election in India will set the stage for upgrading that country’s woefully insufficient roads, bridges, airports, ports, and trains. This demand will drive up prices for commodities and basic materials, spreading the growth to major natural resource producers. And maybe – just maybe – all this growth may begin to pull the West itself out of its morass by increasing demand for developed market exports.

This transfer of economic power away from the West won’t be without pain. But Westerners can profit by investing in the emerging market equities, emerging world currencies, and commodities.

These 10 funds are great ways to play the great global shift towards emerging markets over the next few years:

10. WisdomTree Drefuyss Emerging Currency Fund (CEW) —–

The CEW invests in a wide range of emerging market currencies that are likely to appreciate against the US dollar as decoupling unfolds. It includes holdings denominated in such currencies as the Chinese Yuan, Indian Rupee, Brazilian Real, and South African Rand. Currency ETFs like the CEW are best used to keep the smallest, most liquid part of your portfolio safe from a declining dollar.

9. Van Ecks Market Vectors Agribusiness (MOO) 8.16% YTD

A strong recovery in emerging markets will boost commodities off their recent lows. Agriculture is particularly sensitive to strong emerging market growth because increasing prosperity in those countries actually brings millions of people living on subsistance into the global food economy for the first time. The MOO invests in international agribusiness companies like PotashCorp (POT) and smaller developing market firms like Kuala Lumpur Kepong Bhd (PINK:KLKBF) that will benefit from this long term trend.

8. CurrencyShares Australian Dollar Trust (FXA) 9.22% YTD

If there is one developed market currency that will benefit from strong growth in the emerging world, it is the Australian Dollar. The AUD is a true commodity currency, as its value is highly dependant on Oz’s natural resource exports, which are in turn driven primarily by growth in emerging markets.

7. SGA Dow Jones Emerging Markets Energy Titans (EEO) —–

This brand new fund invests in 40 publicly traded energy firms in emerging markets. The fund is naturally weighted towards the Russian names, which make up about a third of the holdings. But it also hold the majors from other emerging nations including Petrobas (PBR), PetroChina (PTR), Reliance Industries (BOM:500325), and Sasoil (SSL). It faces liquidiy risk at the moment, but will likely become a widely held fund in the future.

6. iShares S&P Global Materials Index Fund (MXI) 19.62% YTD

Infrstructure development requires the proper materials, and the MXI tracks globally active firms in that business. It includes major mining players like BHP Biliton (BHP), chemical firms such as BASF (OTC:BASFY), and metals concerns like China Steel Corp (TPE:2002). It is heavily weighted towards firms headquartered in developed markets, but most are international conglomerates with strong operations in the emerging world

5. PowerShares Commodity Index Tracking Fund (DBC) 5.62% YTD

Strong economic growth in economies that represent 40% of the world’s population will assuredly firm up commodity prices. The DBC invests in the six most traded commodities- crude oil, heating oil, aluminum, wheat, gold, and corn- all of which will be winners when emerging markets dominate world growth.

4. Claymore/Delta Global Shipping Index (SEA) 16.62% YTD

The SEA invests in companies engaged in the global shipping industry, which will stage a strong recovery as global trade volumes recover and emerging to emerging exchanges rise. It holds almost exclusively maritime shipping companies like Navios Maritime (NM) , Cosco Corp Singapore (SIN:F83), and Euronav (EBR:EURN) . It aims to cover the complete breadth of the global shipping trade – everything from oil tankers to dry bulk. So if trading volumes go up on anything, this ETF should do well.

3. PowerShares Emerging Markets Infrastructure Portfolio (PXR) 38.52% YTD

The PXR is notable among infrastructure funds in that it invests almost exclusively in the firms that build infrastructure, and not in companies that operate and maintain infrastructure. That distinction is important as the action in the next few years will be in designing and building projects, not profiting for those already built. The fund holds mostly emerging market leaders, although it contains a few Western companies like ABB (ABB) and Ingersol-Rand (IN) that are deeply involved in emerging economies.

2. iShares MSCI BRIC Index Fund (BKF) 38.45% YTD

A broad emerging market equity fund should be the cornerstone of a decoupling portfolio. A true emerging market ETF- like VWO- would be an acceptable choice. But emerging market funds often include middle income economies like South Korea, Mexico, and Poland which may not decouple so easily. The BKF gives you broad, solid exposure to the four core emerging markets, and does so at a cheap .48% expense ratio. A buy for any diversfied portfolio.

1. First Trust ISE Global Engineering and Construction Index Fund (FLM) 10.67% YTD

Villagers in India don’t need iPods or hot new diabetes drugs. They need reliable electricity. And the boring firms that help build power lines in emerging countries will be the true winners in the new decoupled world economy. The FLM invests in firms that specialize in the relatively profitable business of designing and building infrastructure products. It includes big Western companies like Bouygues (EPA:EN) and URS (URS) as well as emerging gems like China Communication Construction Company (HKG:1800) and Orascom (CAI:OCIC). It differs with the PXR mostly with its greater inclusion of big-margin engineering and design firms, and a lesser focus on materials and equipment. Its underperformance YTD compared to the PXR is largely due to the fact that it fell much less during 2008. FLM a thinly traded fund, with real liquidity concerns. But its unique nature leaves big potential for upside, making it a risk worth taking for those comfortable with risk.