ETF Prime Archive

Me and My Renminbi

One ingredient, one very, very big ingredient, has been lacking in the menu of emerging market currency plays: the dollar de-coupling of the only true 800 pound gorilla of emerging market central banks.

At long last, though, that may be changing. The Financial Times reports that later this month China will, for the first time, sell renminbi-denominated bonds to offshore investors.

While the size of the sale is rather modest at Rmb 6 billion (approx. $879 million), it represents an important first step in the integration of China’s sovereign debt and currency with global capital markets – characterized as a move to “improve the international status” of the renminbi.

FT reported that the Chinese government has taken several steps to promote the use of the renminbi in settlement of trade with China. But a viable presence in international sovereign debt markets is also regarded as critical to providing foreign investors the means by which to hold renminbi-denominated Chinese debt.

Globally, once recovery-related demand kicks in and government stimulus spending tabs come up for payment, inflation and very lumpy government debt issuance and money-printing appetites are likely to emerge – on a scale without historical precedent – particularly in developed markets such as the U.S.

That environment will have risk managers and investors leaning heavily on physical assets and currencies to manage risk and to benefit from massive macro trends. Emerging market currencies, given the far more robust growth rates likely to be experienced by emerging economies, are poised to play an increasingly important role.

Given the aggressive historical pegging of the renminbi to the dollar, it’s not surprising that neither product market nor investors have yet rushed to stake out positions in the currency. In fact, at present there are only two renminbi currency Exchange-Traded Products (ETPs – an exchange traded fund, or ETF, and an exchange-traded note, or ETN).

For emerging market currencies that are able to float more freely there’s already an abundance of choices – covering individual currencies of Brazil, India, Russia, Mexico and South Africa as well as emerging markets currency baskets that also include Turkey, Poland, Chile, Taiwan, South Korea and Israel.

And now the stage is set – at least for the first Act – in what promises to be an important rise to prominence of the renminbi and, for investors, the evolution of an asset segment that may prove to be quite important down the road. Keep your ear to the ground on related news and keep your eye on CYB and CNY for evidence of a more dynamic renminbi /  dollar performance than what we’ve seen in the longstanding pegged currency regime – it’ll take some time to really get rolling.

ETFs Continue to Take Market Share

The latest ICI fund data shows that ETFs continue to take market share from mutual funds.  As of the end of July, ETFs represented 8.6% of all non-money market funds.  In 2005, ETFs represented only 3.5%, notable because that’s the year non-money market mutual funds reached their peak in terms of total number of funds.  Since that time, the number of mutual funds has decreased by 466 and assets in mutual funds have decreased from a peak of $8.9 trillion in 2007 to $6.8 trillion currently. 

While it’s easy to point to the recent market collapse as a primary culprit in the decrease of mutual fund assets, one only has to look to ETF assets to see what’s really driving the decline of mutual funds – investors are realizing the potential benefits that ETFs can offer including lower costs, more transparency, tax efficiency, and better, more direct access to alternative asset classes.  While mutual fund assets have decreased, ETF assets have increased from $608 billion in 2007 to $640 billion currently.

ETFs still have some ground to cover (and it’s important to note that ETFs haven’t even begun to significantly penetrate the 401k space – the key driver for mutual fund assets), but the growth trend is too obvious to ignore.  If you haven’t explored the potential benefits of ETFs, now may be the time to do so.  There’s a reason investors are moving into ETFs and out of mutual funds.

Why Emerging Markets Are Attractive

As the global economy starts to shows signs of improvement, many analysts think that emerging markets are attractive and for good reason.

As these nations build infrastructure and their consumer spending increases, emerging economies often expand faster than their developed counterparts.  In 2008, the gross domestic product (GDP) of both China and Brazil grew more than 7% compared with just 1.1% for the United States.  Much of this growth was fueled by building and improving infrastructure and the relatively low amount of consumer debt found in these nations, which enabled them to expand faster than more developed economies.

Economists expect these nations to continue to grow, which could further create opportunities for strong corporate profit growth, and in turn appreciation in stocks.  However, one must keep in mind that investing in these nations is riskier than investing in developed countries.  Emerging economies can suffer from unstable political, legal and financial systems, volatile currencies and liquidity issues. 

A good way to access emerging markets is through the following ETFs:

• The iShares MSCI Emerging Markets ETF (EEM), which is up 79% from its March low. 
• The Vanguard Emerging Markets Stock (VWO), up 83% from its March low.
• The Emerging Global Shares DJ Emerging Market Titans Composite (EEG), which is a new ETF, but enables investors to grab exposure to parts of the world the other two don’t and is up 5% since its inception.

Protecting Recent Gains

Since the lows struck on March 9th by major US equities indexes, US equities have rallied 50%, international equities 70%, commodities 25% and US REITs 85%!

Yet, if things have been so darned good, then why do most investors feel so badly and so beat up?

The nature of compounding and recovery from negative returns is that it takes a 33.3% return to fully recover from a 25% decline in value.  It takes a 100% return to fully recover from a 50% decline in value and it takes a 300% return to fully recover from a 75% decline in value.

Accordingly, apart from fixed income and relative to October 2007 levels, most asset classes are still 25% to 50% in the hole! … And that’s why most investors still very much “feel the pain.”

So what steps can investors take to help protect recent gains while continuing to participate in the market?

With such extended and disparate gains across equities, fixed income and alternative asset classes and subclasses, it might make sense for buy-and-hold, straight asset-allocation investors to consider rebalancing holdings to their target allocation.

For other investors – and with nearly all asset classes in positive trend – the current environment represents a great opportunity to consider imposing explicit exit protocols underneath individual holdings.  This can help to protect gains and limit losses in the event of a return to extended negative performance, while maintaining market participation in the present and so long as positive trends persist (i.e., transition to an approach to systematically cut losses short while letting winners run).  Nobody gets any merit badges for fully participating in market declines.