Nine More ETFs Emerge

The second wave of product launches for 2012 contains a pair of “breakeven inflation rate” ETFs, a small-cap emerging Asia-Pacific fund, two low volatility ETFs targeting emerging and developed international markets, new ETFs targeting the regional emerging markets of Latin America and EMEA, an actively-managed fund-of-funds with a global rotation strategy, and a German sovereign debt fund.

ProShares 30 Year TIPS/TSY Spread (RINF) listed on 1/12/12 with an expense ratio capped at 0.75% (RINF overview).  The underlying Dow Jones Credit Suisse 30-Year Inflation Breakeven Index tracks the performance of long positions in 30-year Treasury Inflation Protected Securities (TIPS) and duration-adjusted short positions in U.S. Treasury bonds of the closest maturity.  The difference in yield (or “spread”) between these bonds (Treasury yield minus TIPS yield) is commonly referred to as a “breakeven rate of inflation” and is considered to be a measure of the market’s expectations for inflation.  The index is designed to appreciate as the breakeven rate of inflation increases.  Additional information about the index is available at Dow Jones Indexes.  RINF is implementing this strategy with a combination of swaps and 30-year U.S. Treasury securities.

ProShares Short 30 Year TIPS/TSY Spread (FINF) listed on 1/12/12 with an expense ratio capped at 0.75% (FINF overview).  The new ETF seeks daily investment results, before fees and expenses, that correspond to the inverse (-1x) of the daily performance of the Dow Jones Credit Suisse 30-Year Inflation Breakeven Index.  See the description of RINF above for additional information on the underlying index.  FINF is implementing this strategy with a combination of swaps and 30-year U.S. Treasury securities.

Analysis/Opinion:  RINF and FINF bill themselves as the first Breakeven Inflation ETFs.  However, PowerShares introduced similar inflation/deflation expectation products last month, although they were in an ETN wrapper.  Another major difference is that RINF/FINF target the 30-year spread while the INFL/DEFL pair from PowerShares measures the spread at three different maturities with 5-year securities nominally weighted at 50%, 10-year at 40%, and 30-year at 10%.  This should result in the new ProShares pair having more sensitivity (larger price swings) to changes in inflation expectations under most conditions.

SPDR S&P Small Cap Emerging Asia Pacific ETF (GMFS) listed on 1/12/12 with an expense ratio of 0.65% (GMFS overview).  The underlying S&P Asia Pacific Emerging Under USD 2 Billion Index is a market capitalization weighted index designed to track the investable universe of publicly traded small-cap companies domiciled in emerging Asian Pacific markets.  Country weightings are Taiwan 39.7%, China 23.4%, India 13.8%, Malaysia 9.6%, Indonesia 6.4%, Thailand 5.7%, and the Philippines 2.5%.  Sector breakdown includes Technology 21.6%, Financials 17.1%, Industrials 15.8%, Consumer Discretionary 13.4%, and Materials 12.3%.  GMFS currently has 491 holdings with none exceeding a 1% weighting in the fund.

Analysis/Opinion:  GMFS is the small-cap complement to the large-cap SPDR S&P Emerging Asia Pacific ETF (GMF) (GMF overview).  As is often the case, sector and country representations shift between large- and small-cap segments.  The large-cap GMF has its largest allocations going to China at 37.9% and Financials 25.2%.  Investors often mistake iShares Pacific ex-Japan (EPP) as being a competitive offering to GMF, but there is no overlap as EPP only covers developed markets.

PowerShares S&P Emerging Markets Low Volatility Portfolio (EELV) listed on 1/13/12 with an expense ratio capped at 0.29% (EELV overview).  The underlying S&P BMI Emerging Markets Low Volatility Index measures the performance of 200 of the least volatile stocks of the S&P Emerging BMI Plus LargeMid Cap Index.  Largest country allocations include Malaysia 23.3%, South Africa 18.6%, Taiwan 11.8%, Brazil 9.1%, and Chile 5.9%.  The sector breakdown has Financials at 25.4%, Utilities 15.4%, Consumer Staples 15.2%, Materials 10.1%, Telecommunications 10.0%, and Industrials 9.8%.  

PowerShares S&P International Developed Low Volatility Portfolio (IDLV) listed on 1/13/12 with an expense ratio capped at 0.25% (IDLV overview).  The underlying S&P BMI International Developed Low Volatility Index measures the performance of 200 of the least volatile stocks of the S&P Developed ex US and South Korea LargeMid Cap BMI Index.  Largest country allocations include Canada 20.3%, Japan 16.6%, U.K. 11.4%, Singapore 11.2%, and New Zealand 9.3%.  Sectors with more than 10% weightings include Financials 22.4%, Consumer Staples 17.9%, Industrials 14.0%, Consumer Discretionary 11.2%, Utilities 11.0%, and Health Care 10.3%. 

Analysis/Opinion:  PowerShares is trying to capitalize on the roaring success of its PowerShares S&P 500 Low Volatility Portfolio (SPLV) launched last May [Analysis of New High Beta and Low Volatility ETFs from PowerShares].  Not only did SPLV deliver on its promise of low volatility, but it also generated above average returns while kicking out above average yield.  Although not marketed as a dividend ETF, SPLV is now part of my ETF Dividend & Income Strategy.  I suspect EELV and IDLV will also be success stories.  IDLV has a current yield of about 3.5% while EELV yield data is not available at this time.

iShares MSCI Emerging Markets EMEA Index Fund (EEME) listed on 1/19/12 with an expense ratio of 0.49% (EEME overview).  The underlying index is a free float adjusted market capitalization weighted index that measures equity performance of the emerging market countries of Europe, the Middle East, and Africa (“EMEA”).  The largest of the 131 holdings includes Gazprom 10.0%, Lukoil 4.6%, MTN Group 4.4%, Sasol 4.3%, and Sberbank 4.0%.  The largest sector allocations fall to Energy 28.1%, Financials 24.6%, Materials 15.7%, and Telecommunications 10.6%.  Country weightings include South Africa 44%, Russia 30%, Poland 8%, and Turkey 7%.

iShares MSCI Emerging Markets Latin America Index Fund (EEML) listed on 1/19/12 with an expense ratio of 0.49% (EEML overview).  The underlying index is a free float adjusted market capitalization weighted index that measures equity market performance of Latin American emerging markets.  The largest of the 124 holdings includes Petrobras 7.0%, Vale 6.0%, American Movil 5.6%, and ITAU Unibanco 5.4%.  The five largest sector weightings are Financials 21.5%, Materials 21.1%, Energy 16.2%, Consumer Staples 14.4%, and Telecommunications 8.0%.  Country breakdown includes Brazil at 65%, Mexico 20%, Chile 8%, Columbia 4%, and Peru less than 1%.

Analysis/Opinion:  With these two new ETFs, iShares has begun the process of providing ETFs that divide the emerging markets into three major regions.  They have yet to offer the third region:  Emerging Market Asia Pacific.  However, as mentioned above in the GMFS analysis, the SPDR S&P Emerging Asia Pacific ETF (GMF) is such a fund.

AdvisorShares Accuvest Global Opportunities (ACCU) listed on 1/26/12 with an expense ratio of 1.78% that is capped at 1.80% (ACCU overview).  It is an actively managed fund-of-funds ETF targeting long-term capital appreciation in excess of the MSCI All Country World Index.  The portfolio manager, Accuvest Global Advisors, selects a portfolio of U.S. listed country-specific exchange traded funds (ETFs), using its proprietary multi-factor country ranking model.  Its current holdings and allocations are iShares MSCI Thailand (THD) 21.7%, iShares S&P 500 (IVV) 20.1%, iShares MSCI Brazil (EWZ) 15.6%, iShares MSCI South Africa (EZA) 14.9%, iShares MSCI Russia Capped (ERUS) 13.5%, and iShares FTSE China 25 (FXI) 13.0%.

Analysis/Opinion:  The AdvisorShares fee capping process and description leaves much to be desired.  It states the fees for ACCU will be capped at 1.25%, but the cap does not apply to the acquired fund fee expenses of 0.55%.  Therefore, the actual cap of 1.80% (1.25% + 0.55%) exceeds the stated gross expense ratio of 1.78%.  The ACCU prospectus (pdf) includes a discussion of the past performance of the portfolio manager, including charts and tables showing it underperformed its benchmark for the past 1-year and 5-year periods.

ProShares German Sovereign/Sub-Sovereign ETF (GGOV) listed on 1/26/12 with an expense ratio capped at 0.45% (GGOV overview).  The underlying Markit iBoxx EUR Germany Sovereign & Sub-Sovereign Liquid Index measures the performance of fixed rate debt securities of the Federal Republic of Germany as well as local governments and entities or agencies guaranteed by various German governments.  It has 33 constituents with an average yield to maturity of 1.9% and a modified adjusted duration of 4.8 years.  The fund currently holds about half of its assets in swaps with the other 50% directly in the underlying bonds.

Analysis/Opinion:  The relatively low yield of GGOV will likely make it more sensitive to currency fluctuations than interest rates.  GGOV will compete with PIMCO Germany Bond Index Fund (BUND), which also includes German corporate bonds.  Additionally, there is PowerShares DB German Bund Futures ETN (BUNL), which is an exchange-traded note and does not issue dividends.

Disclosure covering writer, editor, and publisher:  Long SPLV and THD.  No positions in any of the companies or ETF sponsors mentioned.  No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.

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First Seven New ETFs of 2012

Although 2011 produced a record number 308 new exchange traded product offerings and 2012 gets underway with a record 268 names on ETF Deathwatch, ETF sponsors continue rolling out more.

Among the first listings of 2012 were three “volatility response” ETFs from Direxion, which attempt to achieve consistent volatility by controlling equity exposure based on observed volatility.  The first actively managed ETF launch of the year employs a Sector Scoring and Allocation Methodology (“SectorSAM)” to select other ETFs in a market neutral approach.  Two single-country (Singapore and Hong Kong) small cap ETFs were introduced by iShares, along with a fund covering all developed markets of the world.

1) Direxion S&P 1500 RC Volatility Response Shares (VSPR) listed on 1/11/12 with an expense ratio capped at 0.45% (VSPR overview).  The new Risk Control (“RC”) ETF seeks to provide a targeted risk level of 15% (annualized standard deviation) using a quantitative rules-based approach to dynamically reallocate exposure between equities (S&P 1500 Index) and U.S. Treasury Bills (T-Bills).

2) Direxion S&P 500 RC Volatility Response Shares (VSPY) listed on 1/11/12 with an expense ratio capped at 0.45% (VSPY overview).  The new ETF seeks to provide a targeted risk level of 15% using a quantitative rules-based approach to dynamically reallocate exposure between equities (S&P 500 Index) and U.S. Treasury Bills (T-Bills).

3) Direxion S&P Latin America 40 RC Volatility Response Shares (VLAT) listed on 1/11/12 with an expense ratio capped at 0.45% (VLAT overview).  The new ETF seeks to provide a targeted risk level of 18% using a quantitative rules-based approach to dynamically reallocate exposure between equities (S&P Latin America 40) and U.S. Treasury Bills (T-Bills).

Analysis/Opinion: The “RC” in the name stands for Risk Control.  Investors should not confuse the use of “Volatility” in the fund names with other ETFs that track VIX volatility futures.  Instead, for these new ETFs, the measured volatility of the related equity index functions as a throttle to vary the equity exposure as a means of producing the targeted volatility levels.  I am a proponent of targeted-volatility investing and therefore have keen interest in these new products.

Barclays ETN+ S&P VEQTOR ETN (VQT) is another product that attempts to hedge away the negative impacts of volatility.  However, rather than varying the exposure between equities and cash, the underlying index for VQT varies the exposure between equities and VIX futures.

4) AdvisorShares Rockledge SectorSAM ETF (SSAM) listed on 1/12/12 with an expense ratio capped at 1.50% (SSAM overview).  It is an actively managed fund-of-funds ETF hoping to “generate stable and consistent annual returns under all market conditions” using a market neutral approach.  The portfolio manager, Rockledge Advisors, uses its Sector Scoring and Allocation Methodology (“SectorSAM”) to buy sector ETFs it forecasts to outperform the S&P 500 while selling short an equal dollar amount of sector ETFs it believes will underperform. 

The methodology currently focuses on the Sector SPDR ETFs, so only nine sectors are used instead of the ten defined by GICS.  As of 1/22/12, the fund was long Materials (XLB) 34.4%, Technology (XLK) 33.9%, and Energy (XLE) 33.3%.  It was short Financials (XLF) -21.5%, Consumer Staples (XLP) -18.1%, Health Care (XLV) -17.2%, Consumer Discretionary (XLY) -16.3%, Industrials (XLI) -15.4%, and Utilities (XLU) -5.4%.  For the SPDR Select Sector family, the Telecommunications sector is included as part of Technology.

Analysis/Opinion: With indexed ETFs, we can generally expect the performance characteristics to mimic those of the underlying index.  With actively managed ETFs, there is no index, so the sponsor must give us some other means by which to set our expectations.  For SSAM we are told to expect “stable and consistent annual returns under all market conditions.”  However, we are not given any further information regarding the expected annual returns, the standard deviation (stability), or the past performance of the portfolio manager.  On the plus side, SSAM does not have much in the way of competition with Guggenheim Sector Rotation (XRO) on ETF Deathwatch.

5) iShares MSCI Hong Kong Small Cap Index Fund (EWHS) listed on 1/12/12 with an expense ratio of 0.59% (EWHS overview).  The underlying MSCI Hong Kong Small Cap Index is a free float-adjusted market capitalization index targeting the bottom 14% of the capitalization of Hong Kong securities.  The fund has 45 holdings with the largest allocations currently going to VTech Holdings 5.1%, Champion REIT 4.8%, Espirit Holdings 4.8%, AAC Technologies Holdings 4.6%, and Techtronic Industries 4.0%.  Sector composition is heavily skewed toward Consumer Discretionary at 44.1%, followed by Financials 18.5%, Industrials 12.2%, and Technology 9.2%.

Analysis/Opinion:  Blackrock is taking advantage of what I perceive to be the premature closure of IQ Hong Kong Small Cap ETF (former ticker HKK).  Index IQ shuttered its offering in December, just seven months after launch.  As I mentioned in my initial HKK review, Hong Kong small cap funds should have no overlap with the holdings of iShares MSCI Hong Kong (EWH) (EWH overview) and offer vastly different sector exposure.

6) iShares MSCI Singapore Small Cap Index Fund (EWSS) listed on 1/12/12 with an expense ratio of 0.59% (EWSS overview).  The underlying MSCI Singapore Small Cap Index is a free float-adjusted market capitalization index targeting the bottom 14% of equity market capitalization.  The fund has 38 holdings with the largest allocations currently going to Suntec REIT 7.7%, Capitacommercial Trust 7.6%, Venture Corp 4.2%, Biosensors International Group 4.0%, and SATS 4.0%.  Current sector composition has Financials at a hefty 48.8%, then Industrials 18.2%, Energy 6.2%, Technology 6.1%, and Consumer Staples 5.6%.

Analysis/Opinion:  This is the first ETF to offer access to Singapore small cap stocks.  By design, it should have no overlap with the holdings of iShares MSCI Singapore (EWS) (EWS overview) which targets the largest 85% of market capitalization in Singapore.  The top two sectors are the same for both funds with the large cap EWS having 42.9% in Financials and 24.9% in Industrials.

7) iShares MSCI World Index Fund (URTH) listed on 1/12/12 with an expense ratio of 0.24% (URTH overview).  The underlying MSCI World Index is a free float-adjusted market capitalization index targeting the developed markets of the world.  The fund has 1,490 holdings, and the five largest currently happen to all be U.S. companies: Exxon Mobil (XON) 1.8%, Apple (AAPL) 1.7%, International Business Machines (IBM) 1.0%, Microsoft (MSFT) 1.0%, and Chevron (CVX) 0.9%.  Country representation has the U.S. at 52.7%, U.K. 9.8%, Japan 9.1%, Canada 5.2%, and France 3.8%.  Sector breakdown includes Financials 17.7%, Technology 12.0%, Energy 11.8%, Industrials 11.1%, and Consumer Staples 11.0%.

Analysis/Opinion:  The name of the underlying index, and hence the ETF, is potentially misleading because the index does not include stocks from emerging market countries, which currently account for about 15% of the world’s equity market cap.  More appropriate names might be MSCI Developed World, MSCI 85% of the World, or MSCI EAFE + US + Canada.  By excluding emerging markets, URTH can make the claim that it is the only global ETF providing this level of coverage.  If you prefer a “world fund” that includes emerging markets, then consider iShares MSCI ACWI (ACWI) or Vanguard Total World Stock (VT).

Disclosure covering writer, editor, and publisher:  Long XLV and AAPL.  No positions in any of the companies or ETF sponsors mentioned.  No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.

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Health Care ETFs Poised to Repeat Good 2011

The final numbers are in, and 2011 was officially a “flat” year for the S&P 500.  Without dividends, the large-cap stock index was actually down a fraction.  With dividends, it gained only 2.1 percent.

Today we’ll look at some interesting patterns in last year’s sector action — which was quite different from the broad market.  Then I will make an observation about the way 2012 is starting off.

Little Sectors Win the Year

Standard & Poor’s classifies every individual stock into one of ten primary sectors.  They then publish specific indexes for each sector (as well as dozens of sub-sectors within the ten primaries).

So let’s see how each sector performed.  Some were above-average while others lagged.

Hmmm, what’s going on here?  Only three sectors had a losing year, and one of those was off less than 3 percent.  Meanwhile three other sectors had double-digit gains.  So how did the index end up at break-even?

The answer lies in the fact the S&P 500 is capitalization weighted.  This simply means that each stock — and therefore each sector — influences the overall index in proportion to its size.

As of 12/30/2011, the stocks in the S&P 500 had an adjusted market cap totaling almost $11.4 trillion.  Now, as we did above, let’s break it down by sector.

Now the index returns make more sense.  One of the three largest sectors (Financials) dropped 18.4 percent for the year.  The other two biggies (Technology and Energy) had gains in the low single digits.

Conversely, the best-performing sectors tended to be smaller …

Utilities had a great year, but that group represents only 3.9 percent of the S&P 500′s value.  The year’s other two big winners, Consumer Staples and Health Care, are middle sized.  This pair kept Financials from dragging the whole index down.

A Good Time to Stay Defensive

Another thing to notice about last year: The winning sectors were those traditionally thought of as “defensive.”  Utilities, Consumer Staples, and Health Care are often among the best havens in a weak economy.  That was certainly the case in 2011.

Will 2012 be the same?  Of course I don’t know what will happen, but I see some clues.

Utilities had a big rally in the last two weeks of the year.  SPDR S&P Utilities (XLU) gained about 5 percent in that short period … then lost half of those gains in the first week of January.

To me, this looks a lot like year-end “window dressing.”  That’s when portfolio managers pile into the yearly or quarterly winners so their clients will think they’ve been in the best stocks all along.  Once the calendar turned, buying interest dried up and the Utilities sector fell.

Health Care, on the other hand, has shown much steadier recent results.  SPDR S&P Health Care (XLV) actually outperformed XLU in the last quarter of 2011, rising 10 percent vs 8.2 percent for the Utilities ETF.

Bottom line: Not all “defensive” sectors are always equal.  I suspect Health Care will continue to outperform.  If you agree and would like to bet on this trend, here are the five largest diversified health care ETFs to consider:

• SPDR Health Care Select Sector (XLV)
• Vanguard Health Care (VHT)
• iShares Dow Jones U.S. Healthcare (IYH)
• iShares S&P Global Healthcare (IXJ)
• First Trust Health Care AlphaDEX (FXH)

Disclosure covering writer, editor, and publisher:  Long XLV.  No positions in any of the companies or ETF sponsors mentioned.  No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.  This article originally appeared in Money and Markets, a free daily investment newsletter from Weiss Research.  To view archives or subscribe, visit http://www.moneyandmarkets.com/.

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Six Reasons to Avoid Japan In 2012

One of the best ways to make money in ETFs is to not lose money.  I know it sounds obvious, but I can assure you that many people don’t get this key point.  So if I can help you do that, then I count it as a success.  And today I’ll talk about an ETF category I think you should avoid in 2012: Japan.

What’s Wrong with Japan?

I’ve been to Japan many times.  I love the country and the people.  Yet I have to tell you that now is not the time to invest in Japanese stock ETFs.  Yes, I know the Nikkei Dow looks oversold, but it’s looked that way for years.  As I’ve explained before, calling a bottom is tough.  And I don’t think Japan is there yet.  Here are six reasons why:

#1 — Strong Yen

The yen was very strong in 2011 … which is bad news because it makes Japan’s exports relatively more expensive.  And exports are a BIG part of the national economy for Japan.

The authorities are well aware of this, of course, but there isn’t much they can do about it.  The Bank of Japan intervened multiple times last year.  In every case, the impact of their actions was gone within a few days.

#2 — European Recession

A huge chunk of Japanese exports go to Europe.  As you’ve surely noticed, the euro zone is having a few problems.  A severe recession — or at best a few years of low growth — seem likely for 2012 and beyond.

If Europeans have no money to spend, their demand for imports (from Japan and elsewhere) is going to plummet.  This is another bad sign for Japan.

#3 — Hungry Competitors

Japan reached economic success by beating the developed countries in cheap, efficient manufacturing.  Now they have competitors: Taiwan, South Korea, Brazil, India … and of course China.

The challenge for Japan is that all these other countries can do the very same things that put Japan on the map.  And in some cases, they can do it better.  Nations like Brazil have other advantages, too, like better access to natural resources and geographical proximity to key markets.

#4 — Aging Population

Japan is, on average, one of the oldest nations on the planet.  Furthermore, the relatively small number of young adults has a very low birth rate.

The resulting imbalance is making it harder and harder for Japanese industry to keep growing.  Older workers hang on to their jobs for dear life while younger people have no way to gain skills.  We’re seeing a similar pattern here in the U.S., but in Japan it’s a much bigger problem.

#5 — Massive Government Debt

Japan’s national debt is projected to surpass 1 quadrillion yen in 2012.  A big cause is the population imbalance noted above.  All those older people require heavy spending on health care and pensions.

To stay afloat, Japan will almost certainly need to raise taxes on both individuals and businesses.  And higher taxes won’t make it any easier to create economic growth.  

#6 — Political Instability

Japan’s parliamentary government used to work pretty well.  Now it’s turning almost as dysfunctional as Italy and Greece.

Consider this: Japan has had six different prime ministers since 2006.  The current occupant, Yoshihiko Noda, took office in September 2011 and is already under fire.

The real problem isn’t the government; it’s the voters and their unrealistic expectations.  Changing leadership is just a symptom.

Japan-Heavy ETFs to Avoid

Japan may well have short-term rallies in 2012, but I still think the best opportunities will be elsewhere.  Here are some ETFs with heavy Japan exposure:

• WisdomTree Japan Small Cap Dividend (DFJ)
• WisdomTree Japan Hedged Equity (DXJ)
• iShares MSCI Japan (EWJ)
• iShares S&P/Topix Japan 150 (ITF)
• SPDR Russell/Nomura Japan (JPP)
• SPDR Russell MidCap Japan (JSC)
• iShares MSCI Japan Small Cap (SCJ)
• db-X MSCI Japan Currency-Hedged Equity (DBJP)
• MAXIS Nikkei 225 Index Fund (NKY)
• Vanguard MSCI Pacific ETF (VPL) (62% allocation to Japan)

If any of these are in your portfolio, I suggest you look for a chance to get out as soon as possible.

There is an ETF that is designed to go up as Japanese stocks fall.  ProShares UltraShort MSCI Japan (EWV) is a 2x leveraged inverse fund.  However, I don’t recommend EWV as a long-term investment.  It is a short-term trading instrument.  (See Three Overlooked Risks of Inverse ETFs to learn more.)

So what do you do with the cash you aren’t investing in Japan?

Good news: You have plenty of opportunities elsewhere.  I’ll be telling you about some of them in my Money and Markets columns as the year unfolds.  And if you’d like more specific recommendations on what to buy and sell, click here and check out my International ETF Trader service.

Disclosure covering writer, editor, and publisher:  No positions in any of the securities mentioned.  No positions in any of the companies or ETF sponsors mentioned.  No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.  This article originally appeared in Money and Markets, a free daily investment newsletter from Weiss Research.  To view archives or subscribe, visit http://www.moneyandmarkets.com/.

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