BrokerAdviser.com - ETFs--Seeking a New Frontier?

Volume 3, Issue 26
June 24, 2008

ETFs--Seeking a New Frontier?

By Nancy Zambell, Contributing Editor

First pioneered by the American Stock Exchange in 1993, ETFs have seen their numbers soar over the past year and a half. Today, there are more than 700 ETFs, scattered among just about any investment category you can imagine.

And now, with the introduction of several more interesting ETF options, I thought it was time to once again address the industry and let you know what's new.

But before I get to that -- for our new subscribers or for novice ETF investors -- let's review how ETFs differ from mutual funds:

ETF expenses are significantly less than most mutual funds. Trading in ETFs does require a broker, albeit, a commission. However, the total expenses (unless you are an active trader -- and if that's the case -- you shouldn't be in ETFs), are, on average, much lower than the expenses of mutual funds investing in similar asset categories.
Liquidity and transparency. ETFs can be traded all day long, instead of just once daily for mutual funds. You buy and sell them just like stocks. And unlike mutual funds, with ETFs you can use limit orders sell them short and trade options.
Less capital gains distributions. Investment turnover in ETFs is not as frequent as in mutual funds, lending themselves to lower capital gain distributions, hence, a smaller tax bite for most investors.

Investors can help themselves to market-, dividend-, earnings- and sales-weighted ETFs. You can also find plenty of commodity, country and sector exchange-traded funds. Actively-managed ETFs are growing in popularity, and with recent economic woes (with sectors such as housing and financials coming under fire) short ETFs have grown considerably, which leads me to the latest updates on the ETF market.

MacroMarkets has just announced that it has filed with the SEC (Securities and Exchange Commission) to launch two new ETFs to bet on rising or falling home prices. The ETFs will be based on the S&P/Case-Shiller Composite 10 Home Price Index, the leading index of home prices in 10 major metropolitan markets.

The MacroShares Major Metro Housing Up (NYSE Arca: UMM) ETF will deliver two-times the return of the benchmark index and the MacroShares Major Metro Housing Down (NYSE Arca: DMM) will deliver two-times the inverse return of the index. They are a little complex, so you may want to consult the following website for the details (http://www.indexuniverse.com/sections/breaking-news/10/4202-macroshares-housing-.html), but here's the gist of it, according to Breaking News:

"If home prices go up, assets are shifted from the Down Macro to the Up Macro, and vice-versa. The only asset they hold is Treasuries, and those Treasuries are simply shifted from one fund to another depending on the price point of the index. Because they hold Treasuries, the new funds also provide income. Because they work like a teeter-totter, the down fund can only fall 100% (reflecting a 50% drop in house prices) while the up fund can only rise 100% (reflecting a 50% rise in home prices). After that, the funds will be liquidated and investors will be paid based on the net asset value. After 10 years, the funds will be liquidated."

Additionally, the index is reported monthly, but has a two-month lag and the ETF's net-asset values will be based on this lagging index price.

More short-based ETFs are also on the way from Rydex, who is offering inverse and leveraged inverse ETFs in the energy, financial, health-care and technology sectors. The benchmarks for the new ETFs are 200% of the performance of the underlying index.

Rydex 2x S&P Select Sector Energy ETF (Amex: REA)
Rydex Inverse 2x S&P Select Sector Energy ETF (Amex: REC)
Rydex 2x S&P Select Sector Financial ETF (Amex: RFL)
Rydex Inverse 2x S&P Select Sector Financial ETF (Amex: RFN)
Rydex 2x S&P Select Sector Health Care ETF (Amex: RHM)
Rydex Inverse 2x S&P Select Sector Health Care ETF (Amex: RHO)
Rydex 2x S&P Select Sector Technology ETF (Amex: RTG)
Rydex Inverse 2x S&P Select Sector Technology ETF (Amex: RTW)

To take advantage of soaring oil prices and to feed our environmental consciousness, several green ETFs are being launched:

PowerShares Wilderhill Clean Energy Portfolio Fund (PBW)
Claymore/MAC Global Solar Energy (TAN)
Van Eck Global Alternative Energy (GEX)
Van Eck Global launched the Solar Energy ETF (ASE: KWT)
Market Vectors Global Nuclear Energy (NLR)
First Trust ISE Global Wind Energy Index Fund (FAN)

The push for alternative energy is tremendous. Oil prices are bringing greater attention back to nuclear energy. Solar continues to be an expensive way to provide energy, but as more companies further develop cheaper technologies, it may yet have its day. Wind is also gaining ground. According to the American Wind Energy Association, wind power grew to nearly 30% of all new electricity-generating capacity added in 2007, up from less than 1% in 2002. Expect to see many more advances in these fields, as well as potential investment opportunities, in the near future.

Next, a new take on international investing is being offered via frontier ETFs. These ETFs are based on frontier markets -- the next generation of emerging markets.

Hot off the press is the Claymore BNY/Mellon Frontier Markets ETF (NYSEArca: FRN), based on the Bank of New York/Mellon index. The ETF will cover investments in 41 frontier markets in the Middle East, Eastern Europe, Africa, Latin America and Asia, via American Depositary Receipts and Global Depositary Receipts. The majority of the fund will come from companies in Poland, Chile, Egypt, Kazakhstan, Peru and the Czech Republic.

Coming soon is the PowerShares MENA Frontier Countries Portfolio (PMNA), which will invest in some 50 companies, mostly in Nigeria, Egypt, Morocco, Oman, Lebanon, Jordan, Kuwait, Bahrain, Qatar and United Arab Emirates.

There's no question that more frontier ETFs are on the horizon. But investors need to know that frontier markets don't mean the same to everyone. Goldman-Sachs defines 11 countries as frontier markets, Standard & Poor's defines 37 and Merrill Lynch defines 17.

Consequently, it is essential that you do your homework and know exactly which companies and countries your ETF includes. And just like with emerging markets ETFs (and probably even more so), frontier ETFs will offer greater return, but also greater risk. Therefore, investors must tread this market with a careful approach.

As you can see, the exchange-traded fund industry continues to grow by leaps and bounds. And as more 401(k) programs embrace ETFs, investors will likely see a proliferation of unique ETFs being offered. But as with any investment, it pays to me careful. So make sure you read the fine print, watch expenses, check out the underlying indexes, compare return figures (if available) and, most of all research the included companies to make sure that they meet your investment standards and goals.

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

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