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Indonesia, after an extremely disappointing 2012 in which the country severely lagged other emerging markets, had a great start to 2013. The country’s markets performed quite well in the first few months of the year, outpacing broad emerging market indexes by a pretty wide margin.

In fact, top funds tracking the Indonesian market have gained over 25% on the year, compared to year-to-date losses for (EEM - ETF report) and (VWO - ETF report), the two biggest emerging market ETFs on the market today. While this obviously represents an enormous level of outperformance, there have been some cracks showing in the story lately, largely thanks to some extreme weakness in the Indonesian currency, the rupiah.

Rupiah Weakness in Focus

The rupiah was in a relatively narrow range against the dollar for the past eight months of roughly between 9,650 rupiahs per dollar and 9,900 rupiahs per dollar. In recent trading though, the currency has broken out higher (weaker) against the dollar, crossing the 10,000 rupiah per dollar mark, and threatening to take out the 10,100 level as well (read Tough Times Ahead in Commodity Currency ETFs?).

According to Bloomberg, the reason for this drop in the currency is largely due to concern over foreign demand for Indonesian securities, and worries over a shortage of dollars. These concerns stem from overseas investors pulling out roughly $800 million so far this month from the country’s investable securities, while a string of quarterly current account deficits are making it difficult to keep dollars at home as well.

“The rupiah’s fundamentals look very weak,” said Khoon Goh, a senior strategist at Australia & New Zealand Banking Group Ltd. (ANZ) in Singapore via a Bloomberg article. “Given its large current-account deficit, Indonesia needs to attract $1 billion of portfolio inflows each month just to keep the rupiah from depreciating.”

Thanks to this perception, rupiah forwards are now looking for further losses for the Indonesian currency, suggesting that the problem may continue in the near term. And even if it doesn’t, investors should note that the currency’s implied volatility has also moved sharply higher, suggesting that no matter what the outcome over the next few weeks, it could be a choppy time for Indonesian investing (see Invest in Indonesia, the Rising Star of Asia).

Indonesian ETF Impact

Since Indonesian ETFs hold Indonesian securities denominated in rupiahs, they can be impacted by exchange rate moves, in addition to stock price movements. While this can be favorable when the rupiah is strengthening, it does drag on performance during periods of currency weakness, like with what we are seeing now.

Furthermore, the cloud of uncertainty caused by the recent run of issues doesn’t help matters either. This is especially true given Indonesia’s status as a relatively volatile emerging market, and a general lack of emerging market demand at this time (see Southeast Asia ETF Investing 101).

Given this, the difficult period could continue for Indonesian ETFs, and possibly other funds targeting countries in the region. With this backdrop, investors interested in emerging markets should pay close attention to the following Indonesian ETFs as they could be in for some rough trading in the days ahead as well:

Market Vectors Indonesia ETF (IDX - ETF report)

This is the oldest Indonesia ETF on the market, tracking the Market Vectors Indonesia Index in order to give investors broad exposure to the Southeast Asian market. The ETF holds about 40 stocks in its basket, charging investors 57 basis points a year in fees.

This large cap focused product saw big volume in Monday trading, roughly three times the normal amount, losing about 4.3% on the day. This continues the rough stretch for the fund, as the product is now down double digits over the past ten days.

iShares MSCI Indonesia Investable Market Index Fund (EIDO - ETF report)

The most popular Indonesia ETF, EIDO follows the MSCI Indonesia Investable Market Index, another large cap focused benchmark for the island nation. This fund though, holds about 100 stocks in its basket, charging investors 60 basis points a year in fees for this exposure.

This ETF also faced sluggish trading for the Monday session, losing about 4.3% on elevated volume levels. The product is actually the worst performer of the group, having lost about 11.1% in the past ten day time frame (read Indonesia ETFs: Can the Run Continue?).

Market Vectors Indonesia Small Cap ETF (IDXJ - ETF report)

IDXJ is the least popular of the group, but it is also the only fund that focuses in on the small cap corner of the Indonesian market. The fund tracks the Market Vectors Indonesia Small Cap Index, holding about 25 companies and charging investors 61 basis points a year in fees.

Although small caps are generally higher volatility securities, IDXJ hasn’t experienced as much of a sell-off, losing about 3.4% in Monday trading, although volume was about triple the normal. Furthermore, in the last ten day period, the ETF has lost just 4.1%, a pretty solid performance when compared to its large cap brethren.

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Author is long IDX

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