One of the easiest mistakes that an investor can make is to chase performance. And one of the easiest places to chase it these days would be in the highest-fliers… the iShares MSCI South Korea Index (EWY) and/or the iShares MSCI Brazil Index (EWZ).
EWY and EWZ have 6 1/2 month gains that a diversified portfolio would be fortunate to receive in 4 years. The iShares MSCI South Korea Index (EWY) and the iShares MSCI Brazil Index (EWZ) have turned in year-to-date performances of 36% and 47% respectively.
Many investors are afraid to go near Dow 14000… which has taken quite a few years to amass percentage returns of this nature. And yet, money flows into emerging market regions like the only tomorrow will be more of the same. Up, up and away!
Granted, these are markets that will grow for decades to come. Yet, all investments have a way of falling. And sometimes when they fall, it’s not a glorious buying opportunity. (It shouldn’t be that difficult to recall the IPO/tech/dot-com frenzy of 2000.)
An astute investor should, at the very least, be cognizant of the downside risks to investments like the iShares MSCI South Korea Index (EWY) and the iShares MSCI Brazil Index (EWZ). For example, are people aware that Brazil (EWZ) lost more than 75% of its value from mid-2000 to September 2002? A 75% loss requires a 300% gain… just to break even. (Note: After 7 years, the Nasdaq is still only half-way home to breaking even after losing 75% of its value in a similar time period.)
Granted, the iShares MSCI South Korea Index (EWY) lost only 50% at that time. but who needs to lose 50% of anything, only to double your money in a quick time period?
There are several possibilities for managing the risk of a serious sell-off in emerging markets. Here are a few ideas:
1. Diversify. Is it critical to chase an emerging country’s performance when that single country may be heavily reliant on a single company for its returns? Instead, consider a broad emerging market investment such as the iShares MSCI Emerging Markets Index (EEM). You get 15% exposure to South Korea and 10% exposure to Brazil, as well as a host of other up-n-coming stars. EEM is up 24% on the year so far.
2. Pay Attention To Trends. Every investment has a chart with a 200-day moving average. Although one would not necessarily do well to use this moving average alone for his/her investment approach, a current price that falls below its 200-day moving average is typically a bad sign. Specifically, you may wish to sell part or all of an investment that falls below its 200-day trendline.
3. Use Stop-Orders. The simplest way to control your downside risk is with stop orders. You simply commit to a philosophy that states, "I am only willing to give up X% from the top." With EWY or EWZ, that may be 10%. And then, you may wish to look at other opportunities with the proceeds, or wait for another opportunity to arise. There’s always another opportunity for your cash.
Disclosure Statement: As a Registered Investment Advisor, Pacific Park Financial, Inc. may hold positions in the ETFs, mutual funds and/or index funds mentioned above.