ETF Focus
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ETF Focus concentrates on new ETF product developments and highlights strategies to get the most out of your ETF portfolios.
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Wednesday, February 01, 2006
ETF Innovations
Indexing is not the S&P 500 anymore. There are now more than 200 ETFs on the market. Here are a few of the most innovative.
Exchange-traded funds are essentially index funds that trade like a stock. All ETFs track a specific index and offer investors the advantages of lower costs, tax efficiency and some degree of diversification. When I started Chartwell in 2002 to specialize in ETFs, little did I imagine the current variety of ETFs allowing investors the opportunity to use them to invest in areas such as water, biotech, precious metals and foreign currencies.
Rydex recently introduced the Euro Currency Trust (FXE) ETF which tracks the price of the Euro and last May brought to the market the Rydex Russell Top 50 (XLG) which tracks a market-cap weighted index of the 50 largest mega-caps in the Russell 3000. These two ETFs build on its breakthrough Rydex S&P Equal Weight ETF that tracks the S&P 500 but weights each company equally rather than by the size.
It has outperformed the S&P 500 index by a handsome margin.
The largest family of ETFs is iShares and of particular interest to me is their country specific ETFs which track 22 foreign markets such as Australia (EWA), Brazil (EWZ) Switzerland (EWL) and Taiwan (EWT). iShares ETFs also cover a broad number of sectors, the Morningstar style boxes and are all market-cap weighted.
A new breed of ETFs is the Powershares family. Rather than follow traditional market-cap weighting theory, Powershares build indexes based on intelligent models. In short order, it has rolled out a flurry of forward-looking ETFs. Chartwell has built a New Venture ETF Portfolio around Powershares with exposure to Nanotechnology (PXN), Biotechnology (PBE), Water (PHO), Clean Energy (PBW), Aerospace & Defense (PPA) and Media (PBS). The Chartwell New Venture ETF Portfolio is already up over 7% this year.
Looking for a simpler and broader approach to gain global diversification? Try the BLDRS family of ETFs based on the Bank of New York ADR Index. You have four choices: an ETF tracking 50 ADRs in emerging markets (ADRE), one tracking 100 ADRs in developed markets (ADRD), a third tracking 100 ADRs in Europe (ADRU) and last, but not least, one containing 50 Asian based ADRs (ADRA).
But there is a drawback to this explosion of choice. How should an investor pick and choose the right ETFs to meet their investment objectives?
You need to blend your ETFs with a portfolio approach rather than randomly selecting ETFs that capture your eye. First, separate your core conservative portfolio from your growth portfolios. With the core conservative portfolio, your top priority is capital preservation and growth is a secondary consideration. Your growth portfolios are more speculative with capital growth as the primary goal.
Next, you need positions in your portfolios that are likely to offset each other as unexpected events and market movements become a reality. This is not accomplished with different sectors ETFs or a mix of small cap, mid cap and large cap ETFs. Rather the goal is to have some investments that are on both sides of risks.
For example, if the US dollar declines, have some investments in precious metals or denominated in other currencies such as Switzerland or Australia or Singapore ETFs. If inflation heats up have some investments that hedge this risk such as timber, gold or Treasury inflation protected bonds (TIPs). If political events or policies in one country take a turn for the worst, it is helpful to have investments in other well developed countries to offset any loss of value.
You get the idea, spread your risk and avoid having too much exposure to one ETF. You have the tools, now get going building a portfolio that is the envy of your friends and colleagues.
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