Narrowing Your ETF's Focus Can Pay Off Big!

By Nancy Zambell, Contributing Editor

For the past couple of weeks, we have been talking about exchange-traded funds (ETFs), first, discussing several large ETF fund families, and then focusing on gold ETFs.

This week, I want to more-narrowly focus our discussion, delving further into different classes of ETFs, including:

1. Country
2. Sector
3. Target-date
4. Actively-managed ETFs.

The first two we’ll cover this week, and we’ll finish up with the remaining categories in next week’s issue.

First, let’s look at country-specific ETFs. Just as the name implies, these are ETFs that invest in securities of just one country. Right now, Morningstar.com lists 126 international ETFs on its screener, and some 28 of them are single-country ETFs. There’s a wide array of choices. Investors who wish to keep their money in developed countries will find plenty to choose from, including Great Britain, France, Germany and Sweden. And emerging-markets investors won’t find options lacking for investing in Brazil, Russia, India, China, Malaysia, and many others.

The biggest advantage to investing in single-country ETFs is the opportunity to reap big rewards when that particular country’s investments are on fire – as has been the case with India and China for the last few years. Two of the best performing funds in just the past year were the iShares FTSE/Xinhua China 25 Index (NYSE: FXI) and the iPath MSCI India Index ETN (NYSE: IPN), whose 1-year returns were 27.29% and 26.74%, respectively.

However, you only need consider the year-to-date returns to see the downside to country-specific ETFs. So far in 2008, FXI has returned -25.44% and IPN is down -36.41%.

This is a terrific example that demonstrates that investors in these types of ETFs must have a strong stomach for risk. The risk comes in several flavors:

• Many single-country ETFs are thinly-traded, which may cost you more in terms of wider bid-offer spreads and delayed settlements. As well, many also come with higher expense ratios. So make sure you look at the average daily volume traded before jumping into what seems like a fabulous opportunity.

• Because these ETFs are concentrated in just one country, investors’ fortunes rest solely on that country’s economic and political events. One coup or currency devaluation can easily send the entire market reeling.

• Lack of diversification. Many investors become so excited about investing in a specific country, that they forget to make sure that the ETF they select in diversified within the country – meaning across different sectors. A desirable ETF will offer investments in a wide range of different economic sectors.

One of the best reasons for investing in country-specific ETFs is when you own broad-based international ETFs and you want to tweak your portfolio a bit to add coverage for a country that you feel is underrepresented in that particular ETF. For example, an investor who buys one of the ETFs that invest in the BRIC (Brazil, Russia, India and China) region, such as the Claymore/BNY BRIC (AMEX: EEB), may decide that he desires more exposure than the 9.1% Indian investments in EEB. In that case, he may consider the new India ETF, WisdomTree India Earnings Fund (NYE: EPI).

Bottom-line, there are advantages to investing in country-specific ETFs, but also significant risks. Our advice: Be cautious, know exactly what the ETF is investing in, look for diversification, and make sure it fits your personal risk profile.

Other ETFs that are currently appealing to investors are those that invest in sectors. Morningstar.com lists 269 domestic ‘specialty’ ETFs that invest in diverse sectors, including real estate, commodities, natural resources, utilities, health, financial, technology, communications, as well as micro-segments of most of these industries.

Several sectors have recently found favor with investors:

Agriculture. Several catalysts are driving the growth in this industry: Population growth, with estimates forecasting 8.2 billion people in the world by 2030 and the explosion in the alternative energy field, creating opportunities for many crops, especially corn and other grains. Several ETFs are poised to take advantage of this growth, including PowerShares DB Agriculture (AMEX: DBA) and Market Vectors Global Agribusiness (AMEX: MOO).

Metals. Both gold and silver continue to have strong appeal. Last week’s Financially Fit issue went into great detail on the price explosion in gold, and I listed a range of gold ETFs, including streetTRACKS Gold Shares (NYSEArca: GLD) and iShares COMEX Gold Trust (AMEX: IAU). But the price of silver has also been on a tear, more than doubling since 2001. High-tech uses for silver are expanding, while the supply of the metal continues to be tight, boding well for the future. Investors have recently found a couple of silver ETFs to their liking: PowerShares DB Silver (AMEX: DBS) and iShares Silver Trust (AMEX: SLV)

Foreign Currency ETFs are finding new investors as the dollar continues its descent. I discussed investing in foreign currency in our February 12, 2008 Financially Fit issue. There are currently 8 foreign currency ETFs on the market, perhaps a good choice for investors who would like to take advantage of the declining dollar, but who are not interested in playing directly in the FX market. They include CurrencyShares Australian Dollar (NYSEArca: FXA), CurrencyShares Swiss Franc Trust (NYSEArca: FXF), CurrencyShares Euro Trust (NYSEArca: FXE), and CurrencyShares Japanese Yen Trust (NYSEArca: FXY).

Investors may also want to be on the lookout for sectors that perform contrary to the broader market, especially during whipsaw, volatile periods. In recent weeks, several downbeaten industries such as financials, real estate investment trusts (REITs) and home builders have seen renewed vigor. For example, the PowerShares Financial Preferred (AMEX: PGF) has a year-to-date return of 9.32%, while PowerShares Dynamic Banking (AMEX: PJB) is up 7.42% in the last week, alone.

And the iShares FTSE NAREIT Residential (NYSE: REZ), which owns quite a few apartment REITs, has risen 14.21% since the year began.

Likewise, the SPDR S&P Homebuilders (AMEX: XHB) ETF was up 7.18% year-to-date, while the iShares Dow Jones US Home Construction (NYSE: ITB) has risen 12.71% in the same period.

The primary reason for this divergence is the Fed’s strategy of decreasing interest rates, which often gives a boost to these rate-sensitive industries.

Although, we must caution that the housing market is far from seeing the last of its troubles, with both home sales and prices continuing to decline. And the financials will most likely persist in posting losses due to the subprime mess for sometime to come. Consequently, investors in these sectors should keep a close eye on the economy and also keep these types of investments to a small portion of their portfolios.

And that just makes good sense for any type of sector investing. Like single-country ETFs, sector ETFs are also riskier than broad-market investing. Investors are subject to economic cycles, as well as industry-specific risks, so these ETFs might be preferable for investors looking to supplement or increase their exposure to a particular sector that isn’t covered by another of their investments.

As always, make sure your investments meet your risk profile and keep your more speculative investments to a small portion of your portfolio.

Have a great week!

This concludes this week's issue of Financially Fit.  We encourage you to visit our website to review past issues of Financially Fit:

http://www.brokeradviser.com/newsletter.cfm


Disclaimer & Important Information

Financially Fit is owned and published by Business Financial Publishing, LLC of Washington D.C.  Business Financial Publishing is neither a registered investment adviser nor a broker/dealer.  Readers are advised that this electronic publication is issued solely for information purposes and should not to be construed as an offer to sell or the solicitation of an offer to buy any security.

The views expressed herein are based upon our analysis of the issuer's public disclosures, and assumes both their accuracy and completeness.

The opinions and statements included herein are based on sources (including the companies discussed and public sources) believed to be reliable and in good faith, but no representation or warranty, express or implied, is made as to their accuracy, completeness or correctness. We have not independently verified the information contained herein. This information is not intended to be used as the sole basis of any investment decisions, nor should it be construed as advice designed to meet the investment needs of any particular investor. We encourage you to consult with independent financial advisors with respect to any investment in the securities mentioned herein. You should review a complete information package on all companies, which should include, but not be limited to, the Company's annual report, quarterly reports, press releases and all regulatory filings. All information contained in Financially Fit should be independently verified with the subject company. The foregoing discussion contains  statements which are based on current expectations, estimates and projections, and differences from such expectations, estimates and projections can be expected.

Financially Fit is intended only for residents of the United States. Financially Fit is not for residents of the United Kingdom and is not an approved publication by the Financial Services Authority in the UK.

The information contained in this newsletter is not intended to be a complete discussion of information regarding all of the current and/or intended business activities of the covered companies. Any opinions expressed in Financially Fit are statements of judgment as of the date of publication, are subject to change without further notice, and may not necessarily be reprinted in future publications or elsewhere.

Business Financial Publishing and its members, managers, writers and employees do not accept compensation from the companies discussed within Financially Fit, nor any of our individual newsletter publications (Growth Report, Rising Star Stocks, and Top Stock Insights).

====================
====================

Financially Fit  is a free email newsletter from BrokerAdviser.com (http://www.brokeradviser.com)