ETF Prime Archive

Investing in China with ETFs

From 2003 through 2008, China’s annual GDP growth rate ranged from 9.1% to 12.1%, hitting $4.3 trillion in 2008. By 2020, the size of the Chinese economy is expected to be the second largest in the world behind the US.

China’s economy has created a significant middle class and, as a result, a consumer economy is emerging.  In addition, the manufacturing and service industries in China are undergoing significant development, transformation and growth.

Prior to 2004, the only way to gain exposure to China through ETFs was via a broad emerging markets fund.  iShares then brought the first China-specific ETF to market with its FTSE/Xinjua China 25 Index Fund ETF. The ETF now holds nearly $6 billion in assets and leads a pack of six relatively broad ETFs covering China. In addition, there is a single ETF covering small-capitalization Chinese companies, another covering real estate and two covering China’s currency.

While the selection of vehicles for investing in China has expanded significantly over the past five years, look for continued innovation as the ETF industry develops, as the Chinese economy grows, and as investment access in China improves.

Below is a list of ETFs commonly used to access the Chinese market today:

Exposure		Sponsor		Fund			Ticker
China only		ishares		FTSE/Xinhua China 25			FXI
China only		SSgA		SPDRS S&P China			GXC
China only		PowerShares		Golden Dragon USX China			PGJ
China only		Claymore		China Small Cap Index ETF			HAO
BRIC		Claymore		BRIC ETF			EEB
BRIC		ishares		MSCI BRIC			BIK
Chindia		ishares		FTSE Chindia			FCHI
Chindia		First Trust		ISE Chindia			FNI
Real Estate		Claymore		China Real Estate			TAO
Currency		WisdomTree		Yuan Fund			CNY

Replace Your Tech Stock Fund

When most people think of ETFs, they usually think of broadly diversified index ETFs.  That’s what we generally use at The ETF Store.  Most investors will do well by using those ETFs to build a well diversified portfolio that includes investments in a wide range of asset classes.

I recognize that isn’t good enough for a lot of people.  They want to buy that hot tech stock they see on Cramer every night.  Or they think Apple’s new product is so hot they need to get in before everyone else in the world figures out what Steve Jobs is going to come out with.  If it’s not a hot stock, it’s the hottest tech stock fund highlighted in Money Magazine.

ETFs can now offer an elegant solution to the tech stock jockey who has to have his Google, Apple and Microsoft.  The iShares Dow Jones U.S. Technology Sector Index Fund (ticker IYW) is an ETF from iShares that is focused on the U.S. Tech sector.  It has a heavy dose of the biggest tech stocks (Microsoft was over 11% of fund assets at 3/31/09, Apple 7%, and Google 6%) with all the benefits of mutual fund-type diversification.    What makes it even better is you get the added benefit of transparency, low costs and possible tax savings offered by ETFs.

So if you need to watch Cramer or read Money Magazine, enjoy.  If you have to have tech stocks in your portfolio, though, look to ETFs.

Pimco’s Arrival: What it Really Means

Pimco’s first index-based ETF, the Pimco 1-3 Year Treasury Index Fund (TUZ), started trading last week. The ETF is based on the Merrill Lynch 1-3 Year U.S. Treasury Index.

Ever since Pimco made known last summer its intention to enter the ETF space many in the media have proclaimed Pimco’s entry a watershed event.

So, is Pimco’s entrance that big of a deal? In some respects, yes, in others, no.

What about the product innovation front? Not really – at least not with their first ETFs to market. Pimco is headed into well-covered areas overall. The only truly enhanced coverage among the seven new funds is in the short maturity TIPS and long maturity TIPS offerings – providing improved yield-curve granularity in the TIPS arena.

Here are the first seven Pimco ETFs and corresponding competing ETFs already in operation: 

Pimco 1-3 Year Treasury Index Fund (TUZ)

Been there, done that …

iShares Barclays 1-3 Year Treasury ETF (SHY)

Pimco 3-7 Year Treasury Index Fund

Been there, done that …

iShares Barclays 3-7 Year Treasury ETF (IEI)

Pimco 7-15 Year Treasury Index Fund

Close enough … Been there, done that …

iShares Barclays 7-10 Year Treasury ETF (IEF)

iShares Barclays 10-20 Year Treasury ETF (TLH)

SSgA SPDR Barclays Capital Intermediate Term Treasury ETF (ITI)

Pimco 15+ Year Treasury Index Fund

Close enough … Been there, done that …

iShares Barclays 10-20 Year Treasury ETF (TLH)

iShares Barclays 20+ Year Treasury ETF (TLT)

SSgA SPDR Barclays Capital Long Term Treasury ETF (TLO) 

Pimco Broad TIPS Index Fund

Been there, done that …

iShares Barclays TIPS Bond Fund (TIP)

SSgA SPDR Barclays Capital TIPS ETF (IPE) 

Pimco Short Maturity TIPS Index Fund

Alas, an improvement – greater yield curve granularity for TIPS

Pimco Long Maturity TIPS Index Fund

An extension of the preceding

Here’s where the first Pimco ETF is likely to matter:

Symbolically & level of public awareness

The first index ETF offering by a true behemoth of the active mutual fund space – i.e., the star/sizzle factor. Similar to the excitement and anticipation generated by a gifted, top athlete in one field declaring that he or she will pursue a second sport at the professional level. Bo Jackson’s gig worked and was impressive – for a while, at least, and Deion Sanders fared reasonably well. Michael Jordan’s effort in a differently-configured arena, however, was never productive. Will real impacts demonstrated in the first sport be similar in the second? Always an exciting question.

Getting Michael Jordan or Bo Jackson engaged in a second professional sport certainly didn’t hurt the level of public attention on the games in which they participated. Likewise, Pimco’s presence in ETFland will raise the profile of ETFs among rank-and-file traditional mutual fund investors. This alone may prove to be as important to the industry’s growth as any product innovation that Pimco might bring to the table.

 Fees

At 0.09% – at least for the first two years – fees on Pimco’s first index ETF would be 0.06% lower than the primary competing ETF, SHY. The industry may see a continuation of pricing pressure that an aggressive Vanguard brought to the table on a handful of largely duplicative ETFs if Pimco is to take only well-traveled, well-covered roads as it is with its first ETFs.

Here’s where at least the first Pimco ETF is not likely to matter:

Expansion of the ETF menu for investors

Adding yet another short-term treasury ETF does zippo to meaningfully expand security coverage for the industry and its investors.

Competition for Pimco’s traditional, actively managed mutual funds

Not surprisingly, the first ETF – and those slated to follow – are about as far removed as can be in fixed-income land from the patches covered by Pimco’s actively-managed mutual funds.

Whether Pimco will ultimately play a significant role in the shaping of innovation the ETF landscape will, in part, turn on the question of whether Pimco will limit itself to only creating ETFs that present no competitive threat to its suite of traditional, actively-managed mutual funds. If in ETFs it covers only those areas where it currently doesn’t tread on the active mutual fund side then Pimco will be wading outside of areas for which it’s recognized within the bond arena and, potentially, issuing a string of rather duplicative offerings relative to the industry’s existing lineup. Let’s hope that this isn’t how the story plays out. Still, though, intense fee competition and significantly enhanced public awareness of ETFs are rather bankable outcomes of their arrival.

Innovation on the Sector Front: Emerging Markets

Some investors allocate capital entirely along sector lines. Others use style and capitalization to specify asset allocations. Still others use a combination of the two, employing sector ETFs to overweight holdings within one or more sectors.

Prior to May 21 the universe of sector index ETF families numbered five covering U.S. equities, two covering international developed market equities (ex-US), and one covering global equities (including US). Conspicuously absent from the lineup was an emerging markets sector family.

For those that would employ sector ETFs to cover portions of international developed markets, the ability to allocate along sector lines may be equally important at the emerging markets level.

On May 21 Emerging Global Advisors (www.egshares.com) launched trading on two of a family of twelve ETFs to soon be trading. The ETF family will consist of ten sector ETFs, based on Dow Jones Emerging Sector Titans Indexes, one emerging markets “composite” and one emerging markets industry ETF, also based on Dow Jones emerging market indexes.

The DJ Emerging Markets Energy Titans Index Fund (EEO) and DJ Emerging Markets Metals & Mining Titans Index Fund (EMT) each cover 30 companies domiciled in thirteen and nine countries, respectively. 88% of Energy’s initial country allocation resides in Russia (36%), India (19%), China (16%), Brazil (10%) and South Africa (7%). For Metals & Mining, the top 5 country holdings, representing 94% of the total, include South Africa (31%), Brazil (23%), China (16%), Russia (13%) and India (10%). Company weightings are based on float-adjusted market capitalization and are capped at 10% with adjustment quarterly.

So what might the new emerging markets sector family mean to investors?

Investors using entirely style and capitalization-based allocation disciplines allow sector concentrations to migrate as economic conditions evolve and the business cycle marches on. For those preferring to overweight certain sectors, they soon will be able to do so at the emerging markets level, rather than only at the U.S. and developed market international levels.

For sector allocation investors, the same sector strategy framework one might apply to U.S. and international developed markets will now be possible at the emerging markets level. For sector allocators in international developed and emerging markets, control of sector exposure is the primary allocation objective, with country, capitalization and style distribution remaining migratory in nature. Individual countries tend to have distinct industry concentrations. Purchase of an ETF covering the U.K., for example, would find energy/petroleum and banking to figure prominently in the holdings. Likewise, an ETF covering Switzerland would be expected to have a heavy proportion of holdings in banking and insurance industries. Prior to the roll-out of the emerging markets sector family, sector allocation practitioners had to attack allocation needs to emerging markets through regional, country-specific or thematic alternatives (e.g., BRIC, Chindia) alone.

Emerging Global Advisors indicated that institutional investors constitute the primary target audience for the family of emerging markets sector ETFs. And, apart from tactical plays involving up to only a few of the family at any given time, that’s quite understandable. A challenge for sector-based allocators is to cover the equities landscape with as many as thirty sector holdings (10 U.S., 10 international developed markets, 10 emerging markets). Perhaps the next big innovation step for sponsors of families of sector-based ETF will be to create a single ETF which holds each of the sectors in a prescribed concentration (equal weight or another, relatively agnostic, proportion). This will then allow any “overweighting” to be done with one, two or three of the individual sector pieces – thereby enabling the use of a sector-based approach with one-to-four holdings rather than 10 for each of the equity asset areas (U.S., international developed markets, emerging markets).

Look for this family of ETFs to stick around. Creation of the emerging market sector ETF family addresses specific strategy needs for a meaningful, if minority, slice of the investment community.

Pimco Joins the Party

Pacific Investment Management Company, better known as Pimco, made headlines this week with the launch of its first exchange-traded fund – the Pimco 1-3 Year U.S. Treasury Index Fund (TUZ).  TUZ tracks the Merrill Lynch short-term U.S. Treasury index and immediately becomes the cheapest fixed income ETF on the market with a paltry 0.09% expense ratio.  Pimco’s entrance into the ETF space represents a potentially game-changing moment for the ETF industry.  With investor assets continuing to flow out of mutual funds and into ETFs, Pimco joining the party further pushes ETFs into the mainstream and increases the growing pressure on other high profile mutual fund companies to develop or increase their suite of ETF products.

Pimco, the standard for fixed-income mutual funds, manages over $750 billion in assets with one of the strongest track records in the world.  With its foray into ETFs, Pimco is signaling a shift in the mindset of large mutual fund companies who have been slow to embrace the rapidly growing ETF industry.  With their low cost, transparency, tax efficiency, among other benefits, ETFs have been cutting into the highly profitable mutual fund model.  As we recently explained with Fidelity, the mutual fund giants are facing considerable pressure to move quickly into ETFs as the mutual fund model continues to look less attractive.

Pimco’s foresight to adapt to the quickly changing investment landscape might be the necessary catalyst to push the other large mutual fund companies to develop viable ETF strategies or face getting left behind.  Pimco’s 1-3 Year U.S. Treasury ETF represents just the beginning for the company, as they also announced SEC filings for six additional ETFs:   Pimco 3-7 Year U.S. Treasury Index Fund, Pimco 7-15 Year U.S. Treasury Index Fund, Pimco 15+ Year U.S. Treasury Index Fund, Pimco Broad U.S. TIPS Index Fund, Pimco Short Maturity U.S. TIPS Index Fund, and the Pimco Long Maturity U.S. TIPS Index Fund.  It appears that the party is just getting started.