Sunday, February 06, 2011

Walk Like An Egyptian ETF - With Caution

The world's eyes were until recently glued to Greece, the cradle of civilization.  Now they're mesmerized by that other font of ancient mystery, Egypt.  U.S. retail investors have little access to the Egyptian stock market except through thinly traded instruments like the Market Vectors Egypt Index ETF (EGPT).  This ETF isn't as liquid as others because many of its underlying equities are illiquid, requiring new shares to be handled via in-kind creations.  Van Eck has suspended those creations now that Egypt's turmoil has closed its equity market.  Investor cash intended for EGPT can't be put to work in the fund, so the Egyptian market remains largely inaccessible to new investors despite increased investor attention.  Even ETF experts are unable to estimate a fair value for EGPT thanks to the implied tracking error of all that sidelined cash. 

Daily trading volume in EGPT has exploded in the past two weeks.  Long investors might be betting that the crisis will soon be resolved and stability will return.  Short investors can bet on further chaos.  Value investors need to consider the long-run implications of Egypt's problems.  Credit default swaps on its debt are extremely high, with yields rising due to uncertain bond market interest in new issues.  There is some risk that Egypt's logistics infrastructure can be compromised by political violence.  The Suez Canal seems safe for now but an explosion has taken a very important natural gas pipeline offline.  It is too early to tell whether that explosion was due to sabotage, but any any infrastructure vulnerability puts additional pressure on the military to implement backup measures. 

The risks of investing in emerging markets are obvious.  Egypt is a boiling cauldron right now, and investors can easily get burned. 

Full disclosure:  No position in EGPT.