Watch Out for These 10 ETFs With High Political Risk

By Todd Shriber
May 12, 2010

One of the most interesting elements in the evolution of the ETF marketplace has been their seemingly never-ending popularity. Today, ETFs give investors exposure to countries and regions that were previously hard (or impossible) to access.

Prior to the advent and subsequent growth of country- and region-specific ETFs, the only global markets a U.S. investor could access with relative ease were Canada, Japan and Western Europe.
   
Investing in regions like Latin America, Asia (excluding Japan) and countries like Chile, Russia and Thailand wasn't easy, due in large part to limited choices. The burgeoning ETF industry has changed that, and international ETFs have proven to be among the most warmly received and highly anticipated new offerings ETF issuers can bring to market.

While having a couple of global ETFs in your portfolio is a good idea for diversification purposes, you need to be aware that emerging markets ETFs carry a specific set of risks that have to be considered -- political risk.

When an investor buys shares of an ETF that tracks a developed market like Australia or Canada, political issues are not a big concern. But when an investor delves into emerging markets, political risk needs to be acknowledged and understood.  And when investors assume greater risk, they need to make sure they demand greater returns.

Let's have a look at 10 ETFs subject to political risk, in no particular order:

iShares MSCI Israel Investable Market Index (NYSE: EIS)
Israel's economy has evolved to the point where many analysts have removed the "emerging markets" label. The country's economy is becoming increasingly diverse and Israel itself is politically stable. So why put EIS on this list? That's an easy question to answer.

Israel's closest neighbors by geography aren't exactly friendly. This puts Israel at high risk of falling victim to terrorist or military attacks that could have an adverse impact on equity markets there. In other words, the political risks associated with investing in Israel are a result of geography, not necessarily political issues within Israel itself.

Market Vectors Russia ETF (NYSE: RSX)
No, Russia is not a communist country anymore, but it is far from a democracy. RSX requires some rumination for two big reasons: 1) Russian politics have revolved around one man (Vladimir Putin) for an extended period of time, and 2) Russia depends on natural resources to drive economic growth. Natural resources used to be nationalized, and though now private, many companies that control the natural resources are accused of cronyism.  On their own, either of those factors make RSX somewhat risky. Acknowledging that both factors are at play simultaneously makes RSX doubly risky.

Overall, there are less stable countries than Russia, but investing here still isn't for the faint of heart.  Russia is neither a true democracy nor a true capitalist economy.

Market Vectors Indonesia ETF (NYSE: IDX)
For years, Indonesia was home to pervasive corruption and a debt-laden economy that was doing anything but emerging. In fact, this was more of a frontier market than an emerging market.

A change in political regime has helped Indonesia pare its debt and implement more democratic governing policies. The country's proximity to China has been a boon for its growing economy.

Still, it must be noted that Indonesia has been subject to its fair share of terrorist attacks, and even though it's successfully adopted democracy for now, it is still a fragile concept here.

iShares MSCI Taiwan Index (NYSE: EWT)

The inclusion of EWT on our list follows the same logic as EIS. Taiwan is an emerging market, but it is further along than many other countries with same label.  Its economy is heavily based on exports and technology, not natural resources, which is a good sign for Taiwan's future economic evolution.

Taiwan's proximity to China has been good for its economy, but also increases the political risk associated with EWT.  Taiwan is an independent country, but China does not recognize its independence and desperately wants to put it under Beijing's official jurisdiction. The U.S. is an important Taiwanese ally, so China may not risk further tensions with America by making an overt move to control Taiwan, but the risks here should not be ignored.

Market Vectors Africa Index (NYSE: AFK)
There aren't a lot of investment options for those brave enough to access Africa. There are two country-specific ETFs for Egypt and South Africa and one continent-wide ETF, AFK, which offers exposure to 13 African countries. In general, Africa is the epitome of political risk. Many countries on the continent have to contend with war, political corruption and natural resource-dependent economies. Some countries deal with all three risk elements at the same time.#-ad_banner_2-#Some of the risk with AFK is mitigated by an almost 21% weight to companies not based in Africa. South Africa, the least risky African country from an investing perspective, accounts for another 30% of AFK's weight. But AFK's exposure to unstable nations like Nigeria, Mali, Kenya, Nambia and Angola, makes for an ETF into which you should factor a high level of political risk.

Market Vectors Vietnam ETF (NYSE: VNM)
Vietnam can be considered a true frontier market.  It is still a communist country that hasn't embraced capitalism the way its neighbor China has. Intentional currency devaluations are usually the sign of an unstable economy and Vietnam's government has shown a penchant for devaluing its currency, the dong.

This being said, Vietnam is still a market with potential. If we had to put this list in order of most to least risky, VNM would wind up somewhere in the middle: less risky than AFK, but not nearly as safe as EIS or EWT.

iShares Thailand Investable Market Index (NYSE: THD)

Thailand is fairly typical of a lot of emerging markets -- it is a quixotic blend of profit potential along with political peril. Thailand's economy is more evolved and open than Vietnam, but the political situation definitely needs to be monitored. The country's economy has benefited from a strong trading relationship with China, but Thailand's government is rife with corruption making THD a worthy member of this list.

THD tends to perform well when Thailand's political situation is docile and emerging markets are in favor. Unfortunately, the current political strife in Thailand is marring what could be a promising investment story. Anti-establishment protesters known as the Red Shirts currently occupy parts of Bangkok, and outbreaks of violence have resulted in several deaths. The upheaval has been very bearish stretch for THD.

Global X/InterBolsa FTSE Colombia 20 ETF (NYSE: GXG)
There was a time when Colombia was known for being an unstable, war-torn South American country that Americans were discouraged from visiting due to safety concerns. While Columbia is still most famous for its history as a drug exporter, its economy is quickly changing for the better. The U.S. Department of State still warns American tourists of narco-terrorist groups in certain areas, but notes that security has significantly increased the last few years.

President Alvaro Uribe has reshaped Colombia's economy and image, but a good portion of the risk with GXG lies in the fact that Uribe is due to leave office in 2010. Investors will have to keep a close eye on upcoming development to see if his predecessor can keep Colombia's moving forward.

iShares MSCI Peru All Capped Index (NYSE: EPU)
Peru doesn't often get a lot of attention on its own, but there is an ETF tracking this resource-rich country. Peru has bountiful gold and silver reserves, which provides a very compelling reason to consider investing in EPU.

On the other hand, Peru is very much an emerging market where much of the population lives in poverty.  Latin American countries in general have a long history of tumultuous political swings and military coups.

Market Vectors Gulf States ETF (NYSE: MES)
The countries MES focuses on, Kuwait and the United Arab Emirates in particular, are among the more stable countries in the Middle East. But as we've already mentioned, proximity to political malcontents should be viewed as additional investment risk.

Furthermore, oil is the chief source of economic growth for this region of the world, and if there was ever an investment theme rampant with political risk it is oil. It's hard to find a country in this corner of the world that embraces democracy and capitalism;  these two risks combined with the lack of economic diversity make MES a risky bet.