New Wind ETF

The First Trust ISE Global Wind Energy Index Fund launched this week. The ETF is trading under the symbol FAN – in another example of gimmicky ETF naming.

If oil prices remain high, companies involved in the wind turbine industry may gain significant traction. Wind turbines are common in Europe. The U.S. and Asian markets have huge potential, assuming people don’t get all NIMBY about seeing wind turbines from their backyards.

A couple of recent articles discuss the introduction of this new wind energy ETF:

Should You Buy an Alternative-Energy ETF?

Is Electricity From Wind Just A Lot Of Hot Air?

Dividends: Selecting the best instruments

In an environment where the market is tanking, dividends have returned to the mindset of many investors.

As outlined in earlier HingeFire material, the best place to find straight out dividend yield with some degree of safety is within Master Limited Partnerships (MLPs), Trust Preferred Securities (TruPS), and Royalty Trusts.

A number of recent articles point to Bond ETFs, REITS, common stocks with dividends, and bank stocks as a source of possible dividends. One recent article from Ben Stein pushes investors in these directions. This advice is faulty for many reasons; this is not the time to over-weight these instruments in your portfolio. There are better dividend yield opportunities with less risk.

Bond ETFs normally do not outperform actively managed bond mutual funds. In an environment where the credit risk of bonds is increasing, and spreads increasing while base interest rates are falling; simply bolding a basket of bonds in an index ETF is a recipe for under-performance.

The yields on REITs are dropping as well as their price. Shortly the payouts on many REITS will be on par with safe bank CDs. Investors in REITs are likely to suffer the continued double whammy of falling yields and an equity price drop.

As the economy further deteriorates, the dividends on many stocks will be cut. The most at risk are bank stocks; the earning results due to the subprime crisis have been dismal. Most banks have already cut their dividend payouts; giants like Bank of America (BAC) are likely to still cut their dividends by close to 50%. This would bring the yield to 3.5% rather than the cheery 7.1% gleefully outlined in the article.

From a risk versus yield perspective, the best situations in the market are Master Limited Partnerships (MLPs), Trust Preferred Securities (TruPS), and Royalty Trusts. Investors in search of yield should focus on these instruments over the upcoming 24 months. As always, it is best to hold these types of dividend securities in a tax-free account such as an IRA. Keep in mind that dividend-bearing securities are simply one component of a properly diversified portfolio.

Four Out of Five Wrong

Morningstar touts its own services in a recent How to Find Bargains in Today's Market that outlines “5 Ways to Spot Cheap Securities”. So what is the problem? Four of the five points are absolutely wrong and will only help investors under-perform the market. Let’s take a closer look at the five assertions and why investors should never “follow these points to the letter”.

1) Home in on cheap stocks

“Find those companies that are trading at well below the prices that our equity analyst team thinks they're worth.” The majority of these companies are trading at a discount for a reason; the firms are suffering from industry challenges, mismanagement, or other significant headwinds. Statistically 70% of these companies under-perform over the upcoming 2 and 5 year periods. Just because a company trades at a discount to theoretical value does not mean it is a good investment, in fact many are absolutely horrible.

2) Identify index mutual funds and exchange-traded funds that hold cheap stocks

Remember how well this strategy worked from 1997 to 2001. There are many other time periods where “value” under-performed. Many times an index mutual fund or ETF holding stocks that are selected simply because of their cheap valuation are merely holding a basket of market under-performers. While it is important to consider low expenses in your fund selection, any focus on “cheap” underlying stocks over the potential of the holdings is misguided.

To the second sub-point, many times ETFs and mutual funds trade at a discount to their associated index. Many times this situation continues for years. Knowledgeable investors look for changes from the historical statistical mean of the standard discount as a signal to buy or sell; they do not simply purchase an ETF or fund because it is selling at a discount.

3) Check out newly reopened funds

Usually the reason that funds are re-opened is because they have horribly under-performed and thousands of investors have fled with their cash. Usually these funds are also sizeable meaning it will be hard to correct their course moving forward.

The concept that investors should hunt for reopened funds is dreadful advice. Generally only actively managed funds which do not have a large amount of assets outperform the market. Investors would be better searching for funds with good managers that are not large in size (in terms of total assets).

4) Investigate target-date funds

Target-date funds are designed to allow large mutual fund families to double dip. First they get fees from the under-lying fund and then from the “target-date” fund. Multiple write-ups have called these funds a “pyramid of fees” that are bad for investors.

Investors are better off to understand basic portfolio diversification, and select a set of low-expense funds that meet their needs. Utilizing target-date funds is just asking to be socked with higher expenses.

5) Consider tax-managed funds

There is some benefit to tax-managed funds so this point is not entirely off-course. However many would argue that it is more important to focus on performance over tax-savings in your investing; coupled with the reality that many holdings are kept in tax-free accounts such as 401Ks and IRAs.

Summary

Morningstar comes across as trying to create an article that is merely designed to tout their service offerings. Not that the information services that Morningstar provides are bad, I use them myself for both stock and mutual fund research. Unfortunately most of this pitch is laced with advice that should not be heeded by investors. This serves as a typical example that many articles in the financial press are just simply veiled marketing ploys for services or financial products, and the advice given is not always in your best interest. As always, buyer beware.

One Day Left to Vote: Make your voice heard

Agricultural commodities have been hot over the past few months. Will this trend continue for the remainder of 2008?

Vote Now in HingeFire survey at the top left corner of the Blog.

How will agricultural commodities as represented by the DBA ETF perform in 2008?

What is the cost to beat the market?

Every investor wants to beat the market. Many are willing to spend quite a bit extra in fees, expenses, commissions, and other costs in an attempt to squeeze excess alpha out of Wall Street.

A study, “The Cost of Active Investing”, by Kenneth French, of Fama-French fame, has drawn attention to the price paid by average investors as they attempt to beat the market. What is the total cost? Currently, investors spend for than $100B per year attempting to exceed the returns of a standard low-expense index fund.

A recent NYT article outlined the highlights of the study and associated conclusions. Over time the portion of stocks’ aggregate market capitalization spent on trying to beat the market has stayed near 0.67 percent, demonstrating that the financial industry has continued to find ways to fleece investors over time. Even in a changing environment of reduced transactions costs, reduced sales charges, narrowing spreads, and other beneficial factors – the brokerage firms have found new ways to stick it to normal investors.

Sadly, most actively-managed mutual funds fail to beat the market over time. So in one sense, despite the excess costs burdening investors, non-passive investing normally fails to deliver on the promise to wring alpha out of the market for the average investor.

What is the bottom line? Most average investors would be better off placing their money in low-expense index funds. The fees, loads, and commissions charged by actively managed mutual funds rob investors of more than they gain from the active management over time. It is more important for most investors to think about low-expenses than out-performing the market when creating their diversified portfolio.

One other conclusion not touched on in the article is that only active investors who pay close daily attention to the markets are normally successful in squeezing out excess alpha. Most invest directly in stocks and ETFs rather than mutual funds in order to beat the returns offered by index funds. As a whole, these active investors are more successful than most fund managers over time. Typically these information savvy “power investors” focus on value or momentum for their investment decisions, and utilize advanced computer screening tools that enable them to succeed.

Come Take the New Poll

How will agricultural commodities as represented by the DBA ETF perform in 2008?
Is this market in a bubble or does it have more upside? Let your voice be heard.

The previous survey asked "Now that the 4th quarter earnings are out of the way, is it time to buy banks?" It appears that 45% of the respondents believe that the financial sector will sink by another 20%... and so far they are right on track. With Citi primed to write-down another $18B, the Fed announcing that it is injecting another $50B into the system at both auctions in March, the credit crisis spreading to more forms of debt, and liquidity drying up... the picture appears bleak. Another 30% of the survey respondents believe the banks will at best remain flat. Not much optimism in the banking sector, it is probably not time to bottom fish yet.

Two New India ETFs

Two new India-focused ETFs have come to market. The WisdomTree India Earnings Fund (EPI) began trading last Friday with over one million shares in volume the first day. The PowerShares India Portfolio (PIN) is expected to launch tomorrow.

Including about 150 stocks, the WisdomTree India Earnings Index has a dividend yield of 1.24% and a PE ratio of 13.99. The top five companies represented in the ETF are Reliance Industries Ltd. (13.35%), Oil and Natural Gas Corp. Ltd. (6.27%), Infosys Technologies Ltd. (INFY) (5.78%), Bharti Airtel Ltd. (3.93%) and ICICI Bank Ltd. (IBN) (3.32%). Energy is the largest sector in the index at 24.88%.

The 0.88% expense ratio of the Wisdom Tree ETF (EPI) is cheaper than equivalent closed ended funds such the Blackstone India Fund (IFN) with a 1.23% expense ratio or Morgan Stanley’s India Investment Fund (IIF) with a 1.30% fee.

Investors should avoid the iPath MSCI India ETN (INP) whose issuance remains suspended due to problems with India's foreign capital restrictions. The new ETF products have been designed to meet these requirements and avoid the type of trouble experienced with the iPath MSCI India ETN.

A whitepaper from WisdomTree about the EPI Exchange Traded Fund outlines this new product in more detail.

The new KOL ETF: A one stop source for Coal energy exposure

There is now an alternative to oil exchange traded funds, Van Eck's recently launched the Market Vectors Coal ETF (KOL).

KOL tracks the Stowe Coal Index, which covers 60 companies from around the world that are involved in the coal industry. The index was up over 103% in 2007 and has a three-year annualized return of 43.81%. Pretty impressive performance – and the global demand for energy continues to grow. Global use of coal has risen 65% in the past decade, with much of the increase coming from the Asia-Pacific region. Coal supplies a quarter of the world's energy and is the source of 40% of the world's electricity.

On the other side of the coin, using coal for energy is a significant cause of pollution. Burning coal is proven to be a leading cause of smog, acid rain, and air toxins. Investors with an environmental mindset may pan the KOL ETF.

The index includes stocks from 12 countries. The components companies are involved in five areas of the coal industry; mining and production (73.1%), mining equipment (9.0%), transportation (0.7%), technology (2.3%), and power generation (14.9%). The top five components include China Coal Energy, 8.91%; Bumi Resources, 8.62%; China Shenhua Energy Co., 8.22%; CONSOL Energy Inc., 7.52%; and Peabody Energy, 7.31%.

The overall expense ratio is listed as 1.09%, however the expenses are capped contractually to 0.65% until the end of April for KOL. These figures are expensive for an ETF, but cheaper than most energy focused mutual funds. The fact sheet for KOL can be found at Van Eck's website.

The KOL ETF is likely to continue to rise as the demand for energy continues to grow worldwide over the upcoming years. Many countries continue to strive for an alternative to oil – however only coal is the only economical alternative besides nuclear energy available on a mass scale. Alternative energy programs such as solar and wind still face a significant ramp before they can be economically deployed in scale. The prospects for continued appreciation of the Market Vectors Coal ETF appear to be solid – only time will tell if the performance over the upcoming months matches the previous performance of the index in 2007.


Disclosure: The author does not have a position in any of the equities mentioned in this article. The information provided does not constitute a solicitation to buy, or an offer to sell securities.

Will Actively Managed ETFs Fly

The traditional province of ETFs are passively managed funds which match indexes with low fees. A new breed of actively-managed ETFs are rising. Many folks have questioned whether these ETFs are actually any different from closed-end funds which also trade on the exchanges. Another concern will be if actively-managed ETFs can meet regulatory requirements.

The ETF market exploded due to investors seeking low-fee vehicles which matched indexes; will the firms proposing these actively-managed units be able to exceed market performance while keeping fees low. Do actively-managed ETFs really serve the investor? A recent article from TheSteet.com explores this in more detail - A Push Is On for Actively Managed ETFs.

ETF to Short China

For those who believe that the Chinese stock market is a bubble, there is now an easy way to take action on your convictions. The UltraShort FTSE/Xinhua China 25 ProShare (FXP) moves twice in the opposite direction of the Chinese stock market. The underlying index is the FTSE/Xinhua China 25 Index.

Doubling down on a global downturn
ProShares funds short booming Chinese stocks, other emerging markets
http://www.marketwatch.com/news/story/new-etf-lets-investors-profit/story.aspx?guid=%7B225CDEB1%2DACBD%2D4A6D%2D84CD%2DADF393307D9F%7D&dist=TNMostMailed

Lifecycle that makes sense

Many savvy financial experts are hesitant to recommend lifecycle or target-date funds because many are just a pyramid of fees; burdening the investor with the expenses of both the underlying funds and additional fees for the management of the life-cycle fund. These funds come across to many as just another way for fund families to increase their revenue. Coupled with the reality that very few of these funds outperform their associated indexes, most investors would be better off managing their own diversification.

The crux of the problem is the expenses; automatic lifecycle as a concept works if the fees can be reduced. Fortunately there are a number of ETFs now offered that provide expenses that are typical less then half of most life cycle funds in the market. Target date funds are popular conceptual with investors simply because you can “set & forget”; the advent of life-cycle ETFs are likely to enhance their broad acceptance with the probable added benefit of driving many large mutual fund families to reduce their fees for these vehicles.

TD Ameritrade and XShares have launched five new target-date ETFs; TDAX Independence 2010 ETF (TDD), TDAX Independence 2020 ETF (TDH), TDAX Independence 2030 ETF (TDN) and TDAX Independence 2040 ETF (TDV) and TDAX In-Target ETF (TDX). These target-date ETFs have expense ratios of 0.65%, compared with about 1.3% for the average comparable mutual fund, Other ETF underwriters plan to offer other lifecycle choices shortly, many of these will have even lower expense ratios.

The recent round of pension reform, in which QDIAs were defined by the U.S. Department of Labor, will place lifecycle offerings as the default investments in numerous 401K plans. Many of these retirement plans will likely start considering the ETF lifecycle products as employees clamor for lower fees.

New ETFs Target Retirement Market
http://finance.yahoo.com/focus-retirement/article/103739/New-ETFs-Target-Retirement-Market?mod=retirement-401k