If Emerging Market Bear ETFs Have Bottomed Out, Is It Time To Get Contrarian? (RUSS, RSX, INDZ, FXI)

Scott Martin: Without exception, the worst-performing emerging market funds are those that bet against the rising economic power of countries like Russia, China and India. That’s actually a good thing.

Contrarian funds, typically marketed as “bear market” or “ultra short” portfolios, are designed to deliver the opposite performance as the underlying market they track — often at a multiplier of double or triple the benchmark.

Such funds traditionally acted as a hedge, letting investors manage their downside risk when stock prices in Moscow, for example, are sinking. And over the years, they’ve become vehicles for speculation in their own right among traders hoping to turn a short bet on an entire asset class or market into positive returns.

So far this year, the bear market funds have been the worst performers in the emerging world, which is another way of saying that emerging markets have been performing relatively well against their global counterparts.

The Russia bear fund (NYSEARCA:RUSS), aims to triple the performance of the Moscow stock market in reverse: for every 1% Russian equity prices dip, RUSS theoretically rises 3%.

Year to date, the fund is down 38.55% while the long-only Russian ETF (NYSEARCA:RSX) has climbed 11.82%, so in a broad sense the managers are living up to their mandate, give or take a few percentage points.

We see similar profound losses in the China Bear 3x (NYSEARCA:YANG) and India Bear 3X (NYSEARCA:INDZ) funds, both of which are down well over 36% in the last four months.

When these funds are used as directed, these negative returns should only have acted on a drag on a more balanced bull-oriented portfolio. A trader who invested 90% on RSX and the remaining 10% on RUSS as a hedge would still be up 6.75% — which may be a reasonable trade-off considering the fact that the allocation to RUSS shields the position against outright losses.

If, for example, the Russian market were to execute one of its infamous reverses and drop 20%, the 90/10 long/short portfolio would only decline 12%. That’s still not great, but every bit of downside protection helps in a steep correction like that.

Naturally, those who simply bet all their money on the prospect of Russian stocks declining are hurting now. These are the wages of speculation.

That said, the major emerging bear funds we’ve been talking about have bottomed out in the last few weeks. YANG converted resistance to support at the start of April and is now comfortably riding that line, while RUSS and INDZ have started trending upward.

We could ascribe this kind of move in any one of these funds to simply a tracking correction — after all, RUSS is still 3% below where it “should” be if it were tracking exactly three times RSX in reverse.

Correlations in the other funds have gotten even more out of line. YANG, for example, is a full 13% below where it should be if it had actually been tracking the Chinese market, albeit triple the movement in reverse.

For the managers to be right here, YANG has to soar that 13% to correct from its end. The alternative is for broad China funds like (NYSEARCA:FXI) to surge by about 5%.

Of course, the managers could also be wrong and the funds could continue to track away from their targets. That happens all the time.

But with the big BRIC markets running out of momentum, we can see that the bear funds have the technical upper hand at the moment, so it may be time for traders to start thinking about the opportunities they present — now, while they’re at their weakest.

Written By Scott Martin From Emerging Money

Emerging Money provides insightful and timely information about the increasingly important world of Emerging Market investments. CNBC Emerging Markets Contributor Tim Seymour leads the team of Emerging Money to bring you cutting edge global news and analysis.

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