After a scary sell-off in emerging markets in the past week, investors who specialize in the sector are looking for places to hide while also looking for opportunities to benefit.
And that means finding countries that have stronger economic underpinnings and political stability, while abandoning or betting against those whose current account balances and government budgets are deeply in the red and where there is political turmoil.
The declines have been triggered by signs of weakness in the Chinese economy, including fears it may eventually face a debt crisis, and concerns about how much hot money may exit some markets as the U.S. Federal Reserve pulls back from its bond-buying program. The stimulus that program has given the world economy in the past few years is widely credited with big gains in stocks and other asset prices.
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The benchmark MSCI Emerging Market Index dropped nearly 4 percent over the last five trading days, and after Wall Street's dramatic selloff on Friday it is expected to fall further on Monday. Investors have pulled money out of emerging markets stocks funds in six of the last seven weeks, including a $422 million retreat in the week ended Jan. 22, according to Lipper, a Thomson Reuters company. The losses are exacerbated by plunges in currencies.
Among the strategies being pursued to limit losses or take advantage of the weakness are buying ETFs that have short exposure to Brazil and other Latin American countries, buying funds that invest in mid-cap companies seen as less tied to global turmoil, and investing more in exporters in countries like South Korea and Mexico. These are countries seen having better prospects among emerging markets and the exporters earn revenue in dollars, reducing their exposure to volatility in local currencies.
"This is the time to look at countries and regions that have advantages over others," said Clem Miller, investment strategist with Wilmington Trust Investment Advisors.
Scott Kubie, chief investment strategist at Omaha, Nebraska-based CLS Investments LLC, said he would look to short ETFs exposed to Brazil, pointing to the iShares MSCI Brazil Capped ETF, which fell 2.4 percent on Friday and has lost about 10.1 percent year-to-date. The ETF tracks the MSCI Brazil Index, which tracks the large and mid-cap segments of the market.
"We see that there is some slowing in China, which obviously affects a lot of the material exports that Brazil sends to China," Kubie said. "That's one reason we think Brazil is a little bit less attractive and the one we're most negative on in the broad set of emerging markets."
The EWZ ETF has fallen 10.4 percent below its 50-day moving average, more than just about any other country-specific ETF, according to Bespoke Investments, an investment advisory firm in Harrison, New York.
One of the flashpoints of the selloff is Argentina, as the country's central bank stopped defending the peso and the government eased currency controls. That's caused a 15 percent selloff in the currency in two days.
The Global X FTSE Argentina 20 ETF, which tracks the index of the 20 largest, most liquid names that participate in that country's economy but aren't listed in Argentina, is heavily weighted in materials and consumer staples in the region. It was down 4 percent on Friday and down about 10.5 percent year-to-date.
"The Argentinian government has not been running policies that are attractive for foreign investors for a long time," Kubie said. Since Argentina defaulted on its debt it has been embroiled in disputes with investors, and this has dampened foreign interest in the country.
Most ETFs focused on emerging markets have very little exposure to Argentina, and are more heavily weighted in Brazil.
The ProShares Short MSCI Emerging Markets ETF is one fund that has benefited from the woes. The ETF seeks to match the inverse of the daily performance of the MSCI Emerging Markets Index, which includes a roughly 10 percent weighting in Brazil. It was up 2.6 percent on Friday.
BUYING ON FUNDAMENTALS
Other investors are shifting their mix of emerging markets stocks while maintaining the same overall weighting to the asset class. Miller, the Wilmington Trust strategist, has been shifting assets to funds with bigger weightings in Mexico and South Korea.
"The companies best positioned to withstand this are the exporters that earn their money in dollars," he said, pointing to companies like Samsung on the Korean exchange. The U.S. accounted for 40 percent of Samsung's revenues in its 2012 fiscal year, according to Thomson Reuters data.
Russ Koesterich, global chief investment strategist at BlackRock Inc, also noted that while both countries have not been immune to the sell-off, Mexico and South Korea look more attractive than the index as a whole.
"You can make a distinction between South Korea and some of the other countries that are more vulnerable to hot money outflows," he said. "South Korea, running a trade surplus, also has a fairly significant supply of forex reserves, so it's less vulnerable at least on a fundamental basis than some of the other emerging markets countries," Koesterich added.
Meanwhile, the Mexican government hopes the nation's economy will grow nearly four percent this year and is looking forward to attracting significant investment due to a string of economic reforms passed by President Enrique Pena Nieto.
During meetings in Davos last week, multinational companies PepsiCo Inc, Nestle SA and Cisco Systems Inc announced major investments in Mexico that together totaled more than $7 billion.
Mexico's IPC Index is down 3.5 percent this year, while South Korea's KOSPI is down 4.1 percent.
The lower prices following the sell-off are starting to attract buyers.
Bill Mann, portfolio manager of the $46.2 million Motley Fool Epic Voyage fund, has been buying shares in companies in Turkey and Thailand, both of which have seen significant losses, amid political turmoil. Mann added to his position in Coca-Cola Icecek AS, a $5 billion market-cap company that bottles and distributes Coca-Cola products in Turkey, Central Asia and the Middle East.
The company's shares are down 11 percent for the year, yet Mann sees it as a strong play over the next few years.
"Emerging markets have been ferociously expensive over the last few years and you are starting to see better values with the pullback," he said.
Darell Krasnoff, a managing director of Los-Angeles based Bel Air Investment Advisors, is maintaining his 130 percent overweight position in emerging markets, but has shifted more of his assets to countries like Mexico and South Korea that should perform better than the index as a whole.
"Looking out over the next six to twelve months, you could be frustrated by emerging markets. But looking out over three to five years you should be well served," he said.
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