iShares MSCI Indonesia ETF: Best Vehicle For Indonesia (NYSEARCA:EIDO)

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Opportunity Overview

One of the challenges of investing in emerging markets is finding the right vehicle as a retail investor. This article will cover some of the challenges of accessing the Indonesian stock market on US exchanges:

  • There was previously a CEF (closed fund) listed in the US (Aberdeen Indonesia Fund), but this option is not available.

  • Other funds (i.e. Fidelity Indonesia Fund) have higher fees compared to this Indonesian exchange-traded fund (“ETF”).

  • Indonesian ADRs have extremely low liquidity, so there are very few options available.

  • It would be difficult for retail investors to replicate the performance of the index/fund due to the higher trading costs and lower liquidity of US OTC listings. It is difficult to invest directly in Indonesian stocks.

Therefore, the iShares MSCI Indonesia ETF (NYSEARC:NYSEARCA:EIDO) is one of the best and easiest ways to get to market:

  • The fees for this ETF are very low (0.59%) and it invests directly in Indonesian stocks that are difficult to access for retail investors.

  • There are no major tracking errors or other issues with this ETF, as it tracks the MSCI Indonesia index very closely.

  • The main problem is that almost half of the fund’s assets are invested in financials. The Bank’s NIMs will not benefit from the rate hike.

  • Indonesia’s macroeconomic performance has been quite impressive compared to other emerging markets.

The Indonesian macroeconomic picture is intriguing and capital markets should do well over the next decade:

  • Indonesia is the 4th most populous country in the world and the 14th largest economy.

  • The market capitalization of around $540 billion lags behind its regional counterparts such as Singapore, Taiwan, Thailand, India and South Korea.

  • Inflation has been kept under control compared to other emerging markets.

  • However, Indonesia is not immune to the broader turmoil likely to hit emerging market equities.

I plan to watch the market and accumulate over the next 1-2 years. I will gain exposure to Indonesia by investing in the MSCI Indonesia ETF and 1-2 other ADRs that provide direct exposure to domestic consumption.

No Closed-End Fund Options

Closed-end funds are often one of the best ways to gain exposure to international markets. Although most of these funds mostly trade at around 10% discount, you can access them at 15-20% when the sentiment isn’t as favorable and sell later at 10% or less discount. Additionally, most ETFs provide market exposure and don’t bet on specific stocks, and most closed-end funds are similar to ETFs. One of my favorite closed-end funds in Indonesia that I covered in 2015 is no longer an option as the fund assets were acquired in 2018.

The MSCI Indonesia ETF

The MSCI Indonesia ETF invests directly in Indonesian stocks and only charges a fee of 0.59%. The ETF invests in 90 companies in Indonesia and mainly invests in banks. The ETF is able to track the index closely, as it does not invest in other unrelated international stocks which offer limited exposure to Indonesia.

iShares

iShares

The ETF’s top 10 holdings make up about 62% of the fund’s total assets, and four out of ten of those companies are banks. Therefore, many small and mid caps do not have a significant impact on the ETF because they represent less than 1% of the ETF’s assets.

iShares

iShares

One of the main risks of this ETF is that approximately 44% of its assets are invested in financial stocks in Indonesia. Moreover, it is lower than other favorable themes such as consumer and healthcare companies. Also, banks in Indonesia are not significantly benefiting of rising interest rates. Indonesia’s benchmark interest rate was only 3.5% in August 2022, well below that of many emerging market peers. However, NPLs remained stable at around 2-3% over the last 5 years.

iShares

iShares

However, this exposure to the ETF industry is not uncommon, as financials are typically the largest industry in these ETFs, primarily because most large-cap companies are banks. Sector diversification could lead to liquidity issues for the ETF provider.

Value stocks in Indonesia

The MSCI Indonesia ETF tracks the MSCI Indonesia Index, which trades at around 16x earnings, and invests primarily in financial companies. It is always interesting to watch locally listed value stocks and see why they are trading at a discount to the broader index. This can usually happen due to low liquidity, lack of research coverage, and also because the company is in a lower industry. The MSCI Indonesia Value Index is interesting because it trades at 10.7x future earnings and has several consumer companies in the top 10 holdings.

iShares

iShares

However, in this case, the valuation does not appear to be primarily driven by industry choice, as there are also many consumer companies in the top 10 holdings. A heavier energy or materials index in a frontier/emerging market typically trades at a lower single digit P/E ratio. Romania is a good example.

All in all, it looks like there could be some consumer names to buy for this online business with, or also discounted, the broader market, while also offering superior growth prospects. Some of these stocks above can be accessed on US exchanges (US OTC listings), so this is an option to consider if you want to access Indonesia at a lower valuation.

Investing in ADRs

There are several options available to you if you want to invest in ADRs, but there are several issues to consider:

  • The liquidity of many of them is very low.

  • Brokerage fees can be expensive and not logical if you’re doing smaller trades (you’ll have to invest $1,000 or more in a business to make it worthwhile).

  • Thinly traded U.S. OTC stocks can sometimes trade at a discount to local quotes.

Telkom Indonesia is the most liquid option, and because it does not trade over-the-counter, investors do not have to pay trading fees with most brokerages. Astra International is one of the best bets to consider if you are trading OTC, as the liquidity is appropriate. As you can see, three of these stocks don’t even have a daily turnover above $1,000. Most of these stocks are probably out of reach for most investors due to very low liquidity. Stocks like these can also have a higher bid-ask spread, which can further complicate matters. Also, some brokerages will charge $7 or more to buy some of these companies, so the fee isn’t worth it unless you have a strong interest in Indonesia. A $7 fee on a thousand dollar investment would be around 70 basis points.

The ETF, on the other hand, invests directly in some of these smaller names in the local market in Indonesia, where there may be greater liquidity. Overall, it is nearly impossible for a retail investor to attempt to replicate the performance of the ETF, primarily due to the higher fees, but also due to the lower liquidity associated with some US OTC listings.

Global ETF Comparison

Indonesia has been a relatively safer bet in emerging markets and deserves more attention, in my opinion, due to demographics. Emerging markets have been neglected for the past five years and will likely have another tough year. But emerging markets are certainly due for a bull run later this decade.

Y-Charts

Y-Charts

Indonesia outperformed its regional emerging market peers, as well as the iShares MSCI Emerging Markets (EEM) ETF.

Carry

When limited to US exchanges, the best option is to initiate a position in the Global X MSCI Indonesia ETF, and perhaps add an ADR or two. I plan to follow this ETF and Telkom Indonesia for now.

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