General

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 private investor. This article addresses some of the challenges of accessing the Indonesian stock market on US exchanges:

  • There used to be a US-listed CEF (closed-end fund) (Aberdeen Indonesia Fund), but this option is not available.

  • Other funds (ie Fidelity’s 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 fees and lower liquidity of US OTC listings. Investing directly in Indonesian stocks is difficult.

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

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

  • 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 financial institutions. The bank’s NIMs will not benefit from rising rates.

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

Indonesia’s macroeconomic state is intriguing and capital markets should do well over the next decade:

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

  • Its market capitalization of about $540 billion lags behind regional competitors such as Singapore, Taiwan, Thailand, India and South Korea.

  • Inflation was tame compared to other emerging markets.

  • However, Indonesia is not immune to broader turmoil that may arise in emerging market equities.

I plan to watch the market and accumulate over the next 1-2 years. I 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 option

Closed funds are often one of the best ways to gain exposure to international markets. While most of these funds primarily trade at a discount of about 10%, you can open them at 15-20% when sentiment isn’t as favorable and later sell at a discount of 10% or lower. In addition, most ETFs provide exposure to the market and do not 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’s assets were acquired in 2018.

The MSCI Indonesia ETF

The MSCI Indonesia ETF invests directly in Indonesian stocks and charges only 0.59% fees. The ETF invests in 90 companies in Indonesia and invests primarily in banks. The ETF can track the index closely as it does not invest in other unrelated international stocks that offer limited exposure to Indonesia.

iShares

iShares

The top 10 ETFs account for about 62% of the fund’s total assets, and four out of ten of these companies are banks. As a result, many small and mid-caps have no significant impact on the ETF, as they represent less than 1% of the ETF’s assets.

iShares

iShares

One of the main risks of this ETF is the fact that approximately 44% of its assets are invested in financial institutions in Indonesia. In addition, there are lower to other favorable themes such as consumer and healthcare companies. In addition, banks in Indonesia are not significant advantage of rising interest rates. Indonesia’s benchmark rate was only 3.5% from August 2022, much lower than many other emerging markets. However, the NPLs have remained stable around 2-3% during the past 5 years.

iShares

iShares

This exposure to the ETF sector is not uncommon, however, as financial institutions are typically the largest sector in these ETFs, especially since most large-cap companies are banks. Sector diversification can lead to liquidity problems for the ETF provider.

Indonesia Value Stocks

The MSCI Indonesia ETF tracks the MSCI Indonesia Index, which trades at approximately 16x profit, and invests primarily in financial companies. It’s always interesting to look at locally listed value stocks and see why they trade at a discount relative to the broader index. This can usually happen due to low liquidity, lack of research coverage and also because the company is in an inferior industry. The MSCI Indonesia Value Index is intriguing because it trades on 10.7x Future Profit and has multiple consumer companies in the top 10 companies.

iShares

iShares

In this case, however, the valuation does not appear to be primarily due to industry choice, as there are also many consumer companies in the top 10 holdings. An index that is heavier in energy or materials in a frontier/emerging market usually trades at a lower single digit P/E ratio. Romania is a good example of that.

Overall, it seems there are a number of consumer names to shop for that trade in line with, or at a discount, the broader market, while also offering superior growth prospects. Some of the above stocks are accessible on US exchanges (US OTC listings), so this is an option to consider if you want to enter Indonesia at a lower valuation.

Investing in ADRs

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

  • The liquidity for many of these is very low.

  • Brokerage fees can be expensive, and don’t make sense if you’re making smaller trades (you’d need to invest $1,000 or more in a business to make it worth it).

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

Telkom Indonesia is the most liquid option and since it does not trade OTC, investors do not have to pay any trading fees with most brokers. Astra International is one of the best bets to consider when trading OTC as the liquidity is suitable. As you can see, three of these stocks don’t even have daily sales over $1,000. Most of these stocks are probably out of reach for most investors due to their extremely low liquidity. Stocks like these can also have a higher bid-ask spread, which can complicate things further. In addition, some brokers will charge $7 or more to buy some of these companies, so the fee is not worth it unless you have a strong interest in Indonesia. A $7 fee for a thousand dollar investment would be about 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 can be more liquidity. In general, it is nearly impossible for a retail investor to attempt to replicate ETF performance, primarily because of the higher fees, but also the lower liquidity associated with some of the US OTC listings.

ETF Global Comparison

Indonesia was a relatively safer bet in emerging markets and, in my opinion, deserves more attention due to its demographics. Emerging markets have been out of favor for the past five years and are likely to face another difficult year. But emerging markets are definitely due for a bull run later this decade.

YCharts

YCharts

Indonesia outperformed regional emerging market counterparts, as did the iShares MSCI Emerging Markets ETF (EEM).

To take off

If limited to US exchanges, the best option is to initiate a position in the Global X MSCI Indonesia ETF and maybe add one or two ADRs. I plan to follow this ETF and Telkom Indonesia for now.