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ETF Specialist

Chasing Returns in Emerging Markets

Momentum strategies can work in emerging markets, but beware of execution risks.

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 PowerShares DWA Emerging Markets Momentum Portfolio (PIE) is currently the only fund to offer a momentum strategy in emerging markets. Momentum strategies seek to capitalize on the phenomenon that securities that have recently outperformed will continue to do so in the short run, and those that have underperformed will continue to lag. This passively managed fund tends to perform best, relative to the cap-weighted MSCI Emerging Markets Index benchmark, when there is a large difference between the best- and worst-performing emerging-markets countries. This fund also does not have some of the drawbacks of a cap-weighted index fund--namely, a consistent, significant exposure to government-controlled entities and global cyclical firms.

At first glance, a momentum strategy in emerging markets seems appealing, both on its own merits and relative to a cap-weighted approach. The emerging markets are composed of about 20 countries, each with very distinct economic, political, and social environments. As a result, these countries can have widely divergent stock market performance--for example, in 2011, the MSCI Indonesia Index was up 6%, whereas the MSCI India Index was down 37%. This fund, which tracks an index with no sector or country constraints, can capitalize on these differences. So, in 2011, the fund had an overweighting in Indonesian stocks (with a 13% allocation versus 2% for the MSCI Emerging Markets Index), and an underweighting in Indian equities (0.5% versus 6%). This, along with other momentum-based bets, resulted in a negative 11.4% return in 2011, a significant outperformance relative to the MSCI Emerging Markets Index’s decline of 18.4%.

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Patricia Oey does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.