By Robert Goldsborough
In an ETF Specialist article last June, we published a list of Morningstar's five favorite exchange-traded funds that had been launched in the previous year.
At that time, issuers had launched a slew of exchange-traded products--more than 240 in total--over the previous 12 months. With such a bevy of new products available to investors, we sifted through those launches to come up with five ETFs that to our way of thinking represented the best in innovation, were good uses of the ETF vehicle, offered relatively inexpensive price tags (or in some cases, were downright cheap), and were reasonably distinctive.
Since that time, things have changed in the ETF world. For one, the pace of new launches has slowed down considerably--in the past six months, just 54 exchange-traded products have launched. That implies an annual run rate of just over 100 launches, or less than half of the ETF industry's product-launch rate during 2011 and the first part of 2012. What's more, the number of liquidations of exchange-traded products has stepped up significantly. This environment suggests that issuers have become less interested in throwing anything at the wall to see what sticks. They strike us as being more likely to be thoughtful and judicious about the launches behind which they will allocate resources and less willing to prop up money-losing products.
Even in a reduced-launch environment, however, some interesting new ETFs have launched recently that we think are worthy of investors' consideration. Below we highlight five new offerings from the past six months that offer investors something new--either access to a useful strategy or a new low for an expense ratio. What's more, these all are funds we feel comfortable recommending to investors.
Easing Any Pain From Quantitative Easing: TIPS, Foreign Currency, and Bank-Loan ETFs
In the United States, quantitative easing is continuing, and the Federal Reserve has signaled its desire to keep interest rates low for the next year or two. No one knows whether quantitative easing will result in higher inflation, higher interest rates, and the debasement of the U.S. dollar, but many investors are concerned about these potential outcomes.
Shorter-duration Treasury Inflation-Protected Securities ETFs are less exposed to interest-rate risk, relative to longer-duration TIPS funds, and tend to be more strongly correlated with inflation than long-term TIPS, according to recent research from PIMCO. One new launch in the past few months, Vanguard Short-Term Inflation Protected Securities Index ETF (VTIP - News), offers much to like, with both its average maturity and its average duration clocking in at 2.6 years. VTIP's 0.10% price tag is especially appealing, as it's just half the cost of several large and liquid ETF competitors.
With most investors' portfolios dominated by fixed-rate bonds that face price risk from rising interest rates, investors may want to consider diversifying their bond portfolios with floating-rate securities. One corner of the floating-rate market that has attracted interest from ETF investors is the area of bank loans. Also known as senior loans or leveraged loans, these variable-rate, senior secured debt securities are issued by highly leveraged companies. As such, this asset class is suitable for investors comfortable with the risks associated with below-investment-grade bonds. However, a basket of bank-loan securities in an ETF or mutual fund can offer decent yields for income-hungry investors. What's more, in a rising-rate environment, bank loans tend to outperform fixed-rate securities. An interesting recent launch in this space is Highland/iBoxx Senior Loan ETF (SNLN - News). It's the ETF marketplace's second passively managed fund devoted to bank loans, after PowerShares Senior Loan Portfolio (BKLN - News), which launched in March 2011 and has drawn significant inflows. Both the Highland ETF and BKLN are structured very similarly, tracking rules-based indexes of large, liquid leveraged loans. However, SNLN is cheaper at 0.55%, compared with BKLN's 0.66%. Our only area of concern with this fund relates to the general illiquidity of bank loans.
For investors concerned about the long-term outlook for the U.S. dollar, a recently launched ETF that we like is PIMCO Foreign Currency Strategy ETF (FORX - News). The only actively managed currency ETF holding multiple currencies, FORX holds currencies expected to appreciate relative to the dollar, along with local currency bonds. This fund's appeal comes from its diversification and the fact that it can benefit from the best of PIMCO managers' collective wisdom on where currencies are headed. A caveat: investors should always be mindful of currency investments' dismal long-term expected returns (effectively zero after adjusting for interest-rate differences), the dollar's general role as a safe haven during crises, and the fact that faster-growing foreign countries' currencies don't always appreciate relative to the dollar. However, by the same token, there's clear proof that some active managers can generate positive long-term returns by investing in currencies. In the mutual fund space, Franklin Templeton Hard Currency (ICPHX) is a great example of a currency fund that has taken advantage of the dollar's decline over the past 10 years and generated positive long-term returns. FORX, whose 0.65% price tag is far below the Templeton mutual fund's 1.06% expense ratio, will follow a similar strategy at a reduced cost.
A Cheaper MSCI Emerging-Markets ETF
In general, we are constructive on emerging markets, which enjoy many long-term growth drivers. We also expect improving growth rates in the coming one to two years in many emerging-markets countries, following accommodative monetary and fiscal policies over the past year. In addition, concerns about a hard landing in China have ebbed. With emerging-markets equity valuations low and a better macro outlook, the picture looks bright for the coming months. That said, emerging-markets countries' economies are always at risk of being affected by global market events, which tend to have an outsized negative impact on emerging markets. Slower global growth also can be a headwind.
IShares Core MSCI Emerging Markets ETF (IEMG - News) launched last fall as a part of iShares' way of responding to price competition without giving up fee revenue from existing iShares funds that offer that same exposure. IEMG, which seeks to replicate a market-cap-weighted index of emerging-markets stocks, costs 0.18%, just a fraction of the 0.66% price of the popular IShares MSCI Emerging Markets Index (:EEM). The biggest difference here is that IEMG includes small caps, whereas EEM does not. Over the past few years, an all-cap emerging-markets portfolio has very slightly outperformed a large- and mid-cap index on a risk-adjusted basis. The new fund also is positioned squarely up against Vanguard FTSE Emerging Markets ETF (:VWO), which tracks a different index and also charges 0.18%.
High Dividend Yields and Low Volatility, All in One
With low Treasury yields, investors have flocked to high-dividend-paying ETFs for income. They also have embraced low-volatility stocks, as they've come to understand a persistent market inefficiency. Over the past 50 years, the market's least-volatile stocks have performed about as well as the market, but with considerably less risk, likely because of leverage aversion. Capitalizing on this phenomenon is the final new launch that we like, PowerShares S&P 500 High Dividend Portfolio (SPHD - News). The new ETF is similar to the most popular low-volatility ETF, the $3.6 billion PowerShares S&P 500 Low Volatility (:SPLV). The new fund replicates an index that draws constituents from the S&P 500 Index and then screens for factors relating to dividend payouts and volatility. In particular, the index draws the companies that have shown the lowest realized volatility and that also have produced high trailing 12-month dividend yields. The benchmark then weights constituents by dividend yield. Holding 50 companies, the fund is far more concentrated than SPLV. It also offers different industry weightings than SPLV, holding more financial companies and fewer consumer staples firms. The fund charges an attractive 0.30%. We'd caution investors in this fund to be prepared when markets rise. Historically, during extended bull markets, the least-volatile stocks tend to post extended periods of underperformance.
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