Talking Indonesia ETFs With Van Eck’s Ed Kuczma

by on August 2, 2011 | ETFs Mentioned:

Ed Kuczma is a member of the Investment Team at Van Eck Global, a firm that has a number of ETFs targeting various corners of the market both in equities and in bonds. Currently, Ed specializes in the EMEA region, doing analysis on the various markets that make up these emerging regions. One of the more popular products that Van Eck offers in this space is the Market Vectors Indonesia Index ETF (IDX) which has $800 million in assets. Yet, despite this relative popularity, Indonesia is often overshadowed by larger markets in the space that have managed to steal the spotlight from this rapidly growing nation. Ed recently spoke with ETF Database about the this forgotten market, telling us both the promise and perils of investing in this dynamic country, and how Indonesia can fit into a broader portfolio:

ETF Database (ETFdb): Indonesia is quickly becoming a favorite of many who are seeking emerging market exposure. Why is the country now appearing on many investors’ radars?

Ed Kuczma (EK): I believe that going forward the main highlight for Indonesia as an investment case is based on three pillars: growing domestic consumption, a strong stable financial sector, and an abundance of natural resources that are in high demand from other neighboring Asian countries. I think these factors are sustainable investment themes which will translate in to sustainable growth over the medium-to long-term.  Indonesia has a large and relatively young population. With over 234 million people; it is the fourth largest country in the world in terms of population, which I think a lot of people don’t realize. I think one of the things we are seeing in Indonesia, as well as other emerging markets, is the entrance of a large segment of the population into the middle class. There is a lot of disparity between the upper income level and the lower income level in emerging markets. I think you are seeing this gap start to narrow. Basically, these people are benefiting from rising income levels and wage increases that are higher than inflation, which leads to more disposable income, and the per capita consumption of basic goods is a lot lower than it is in developed markets, so there is room for that per capita consumption factor to increase over time. This is what international investors are gearing their portfolios towards, and is also what multinational companies like Coca-Cola are investing in, in order to benefit from the long-term, sustainable growth in domestic consumption [see Why Indonesia Belongs In The BRIC].

ETFdb: You touched on natural resources earlier. What are some of the resources that Indonesia has that are key exports for its national economy?

EK: First off, Indonesia used to be a member of OPEC due to a sizable amount of natural gas and oil resources within the country but the nation decided to renounce their membership as they became a net importer of oil products, so while they produce a lot of oil, they consume a lot as well. So oil and energy is one piece of their resource base that has potential, if further exploration is conducted. Another interesting investment theme in Indonesia is through the coal sector. Based on the energy needs of neighboring countries like India and China, Indonesia supplies a lot of high quality coal and the coal mines have a long resource life. So, coal is one sector that will experience a high level of investment going forward. I think another important commodity to look at is in the agricultural sector. Indonesia is a supplier of a number of soft commodities given their large land base and favorable geography towards growing a number of crops.  The major cash crops for Indonesia include palm oil, rubber, and plywood. So the energy sector is important, but the agricultural segment is very important as well with rubber and palm oil being in high demand right now.

ETFdb: How do you feel that Indonesia compares to some of the other emerging market nations in the region like Malaysia or Thailand? And what about compared to the BRIC bloc?

EK: When you look at Indonesia, I would say that they have a much more balanced economy than other smaller, yet growing economies, within the region. And if you look at how the economy performed during the 2008-2009 financial crisis, it highlights the diversity of this economy and how resilient growth was. One thing that I like to point towards when you talk about how their economy looks compared to a Malaysia or Thailand, I think they are a lot less vulnerable to global economic cycles and demand from developed markets. And, in reference to the alleged slowdown in China, if China’s demand for commodities and raw materials were to temper a little bit, I think that Indonesia would not suffer as much as other countries in the region because they are not as reliant on the export sector. Export to GDP ratio in Indonesia it is roughly 20%; Malaysia and Thailand are 98% and 70% respectively. Exports and international trade is a much higher component of Malaysia and Thailand’s economy where in Indonesia it is a much more balanced economy, a little more inward looking and more reliant on the domestic economy; it is not as reliant on trade. I think that is one reason why the country has a sustainable, long term growth trajectory that investors will appreciate [Emerging Market ETFs: Seven Factors Every Investor Must Consider].

Looking at the BRIC nations, Indonesia is a little bit lower in rank in-terms of per capita consumption. You therefore have a greater potential to improve the growth and consumption for higher value-added products. We have seen a lot of growth in kind of the basic elements of these emerging markets like cement, rice, beverages, etc., and now I think you are going to get greater growth in the higher value-added products in Indonesia like computers, home-mortgages, televisions, automobiles etc. They are in kind of the next step in terms of evolution of emerging market consumption, which I feel is a positive thing.

ETFdb: So do you feel that an investment in Indonesia is kind of a compliment to a BRIC allocation, or do you feel that it is something that can just stand-alone as an emerging market investment?

EK: The BRICs are the countries that really get the most attention when you talk about emerging markets, and when you look at benchmark weightings for a typical emerging market index, what most mutual funds model their portfolios after, you have China at roughly 20%, Brazil at roughly 15%, Russia and India both around 8%, and as for Indonesia, it is underrepresented at around 2.5% in your typical emerging market benchmark. Given the strong growth in the BRICs over the last decade, Indonesia hasn’t gotten the recognition it deserves, but I think we will continue to see money flow into its economy and that we will see that weighting increase over time. I think that the product that we offer, specifically, the Market Vectors Indonesia ETF (IDX), it gives investor that chance to go overweight in Indonesia and take advantage of these strong fundamentals outside of your typical emerging market ETF. Your EEM and VWO, two of the larger index funds for emerging markets, are solid choices for overall exposure, but for people who want to tilt towards Indonesia on a singular level, I think this Market Vectors product is a great option for investors looking to access Indonesia [see ETF Investing Beyond The BRIC].

ETFdb: We talked a lot about the positives of Indonesia, but what are some of the risks that the company faces in years ahead?

EK: When you look at the nation right now, one of the biggest risks is that the government has a pretty controversial social program in terms of fuel subsidies. As a result, when oil prices spike, Indonesia is clearly at a disadvantage and a lot of that money comes from the government budget to cover the subsidy. There have been ongoing debates on how to lift these subsidies to allow these fuel prices and the local economy to be more market based rather than government based. So there is also a lot of pushback because you can get some protests among the general population if the government were to take these subsidies away. So it is a very delicate process and it is something that the government needs to address going forward. Another risk I think investors should look out for is inflation. I think Indonesia has been doing pretty well relative to other emerging economies in terms of keeping inflation suppressed. They have already gone through a noticeable tightening cycle within the economy. Right now, the central bank is headed towards a more neutral stance with respect to benchmark interest rates, so going forward you do not see substantial monetary tightening and inflation seems to be relatively under control [ETFs For The Next 11 Economies].

Lastly, I would highlight valuations; given the robust outlook for growth for Indonesia and the strong GDP growth going forward and all of the positives I have highlighted today, a lot of investors have already gone overweight Indonesia and they think that valuations are not as cheap as in other countries, but I think given the growth, these companies will grow in to their valuations. It is definitely not a cheap market, so you have to have confidence that the companies will be earning more in the future vs where they are today and have comfort in the economic growth is sustainable.

(In the interest of fairness, investors should also note that iShares also has an Indonesia ETF, the MSCI Indonesia Investable Market Index Fund (EIDO). Investors can compare the two products here.)

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Disclosure: Long IDX, photo is courtesy of Gunawan Kartapranata.