ETF Prime Archive

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.

Stop-Loss and Sell Stop-Limit Orders

As the investment community continues to trumpet the many potential advantages of exchange-traded funds – including lowers costs, tax efficiency, and transparency, one advantage that is often overlooked is the ability to place stop-loss or sell stop-limit orders on ETFs.  Because ETFs trade intra-day on the exchanges like stocks, investors can utilize tools that aren’t available with mutual funds.

A stop-loss order is simply an order placed with a broker to sell a security when it crosses below a certain price threshold.  For example, if an ETF share is purchased for $25.00 and a 10% stop-loss order is immediately placed on the share, the broker will execute the sale of the share at the market price when the ETF trades at $22.50 or lower.  Note that a stop-loss order doesn’t guarantee the trade will be executed at $22.50, only that the sell order will be triggered.  If the price of the security is deteriorating rapidly, the sale could actually be executed at a lower price.

A sell stop-limit order is similar, except that more precise control can be exercised over the sale price.  If a stop is entered at $22.50 with a limit of $22.00, the sale will be triggered once the ETF trades at $22.50 or lower, but the trade will only be executed if the broker can sell at a price of $22.00 or better.  This allows the investor to ensure they receive a certain price or better for the ETF if the sale order is triggered.  It’s important to note that if the price of the ETF quickly gapped down below $22.00 before the sale could be executed, then the sell order would not be filled (versus a stop-loss order where the order would be filled regardless of the price once the ETF hit $22.50 or lower).

While these types of orders are not for everybody and wouldn’t come into play for traditional buy-and-hold investors, these can be useful tools for more active approaches – particularly in the type of market we’re currently operating in.  After a run-up of nearly 50% in the S&P 500 and given the still uncertain economic environment, many experts are concerned that there could be a significant pullback.  While no one knows for sure what will happen, ETF investors can utilize stop-loss and sell stop-limit orders to ensure they lock-in profits and limit severe drawdowns in the event there is a sharp market decline.  In contrast, with mutual funds, sales can only be executed based on the net asset value of the shares of the fund at the end of each day and also require investors to continuously monitor market events.  With ETFs, investors can tend to their busy work and family schedules or go on vacation and have confidence that downside protection is in place.

What is a Unit Investment Trust?

The first exchange traded fund to come to market, and today the most actively traded ETF, the SPDR S&P 500 ETF (SPY), was structured as a unit investment trust (UIT).  In simple terms, a unit investment trust is an investment vehicle which purchases a fixed portfolio of securities, such as municipal or government bonds, mortgage-backed securities, common stock or preferred stock.

The way they work is that the trust purchases the securities and then markets and offers shares of the trust to investors through brokers.  Unit holders of the trust receive an undivided interest in both the principal and the income portion of the portfolio in proportion to the amount of capital they invest.

UITs offer transparency in that their portfolios are selected at the time of deposit and they don’t change until the trust matures.  However, holdings in the trust can be eliminated under extreme circumstances such as deterioration in credit quality, fraud or other irregularities.  They are tax efficient and offer low costs because there is little to no trading activity in the trusts.

To further dissect a UIT, take a look at the above mentioned SPY.  This security represents ownership in a long-term unit investment trust that holds a portfolio of common stocks designed to track the performance of the S&P 500 Index.  In addition to capital appreciation, owning shares of this trust entitles the holder to receive proportionate quarterly cash distributions corresponding to the dividends that accrue to the S&P 500 stocks in the underlying portfolio, less trust expenses. 

To sum it up, a UIT offers many of the same benefits and characteristics of a run-of-the-mill ETF, but one owns shares of the trust and not that of the actual basket of securities.

ETFs Continue to Remain Hot

As the European exchange traded fund (ETF) market continues to glimmer, one of the world’s largest banking and financial services organizations, HSBC, has entered the arena with the introduction of a FTSE 100 Index Fund listed on the London Stock Exchange. 

The HSBC FTSE 100 ETF (HUKX) is designed to track the performance of the FTSE 100 Index, domiciled in Ireland, registered for sale in the United Kingdom and carries an expense ratio of 0.35%.  The newly created ETF will be managed by HSBC Global Asset Management and HSBC Global Markets will ensure liquidity as a market maker.

HSBC is no stranger to the ETF universe, as it is already involved in the ETF markets in Asia through its subsidiary Hang Seng Bank and is a well established provider of services to the global ETF industry as a custodian and market maker. 

To not much surprise, the move into Europe by HSBC was inevitable.  After all, Europe is the leader of the ETF world offering 753 different ETFs of the 1,768 available on the global markets.   Additionally, ETF assets under management in Europe rose 28% in the year to July as compared to 17.2% in the United States. 

As for ETFs in general, total assets globally hit $862 billion in July, 21% above the start of the year and is one reason HSBC plans to leverage its global capabilities and to extend its ETF business across Asia, Latin America and the Middle East.