Currency Harvest ETF Looks Promising

The Powershares G10 Currency Harvest Fund (DBV - PDF Fact Sheet) has steadily gathered assets and has performed very well so far this year with a YTD return of 13.22%.


Here's the definition of what the fund does from the PowerShares website:

The Index is comprised of currency futures contracts on certain G10 currencies and is designed to exploit the trend that currencies associated with relatively high interest rates, on average, tend to rise in value relative to currencies associated with relatively low interest rates. The G10 currency universe from which the index selects currently includes U.S. Dollars, Euros, Japanese Yen, Canadian Dollars, Swiss Francs, British Pounds, Australian Dollars, New Zealand Dollars, Norwegian Krone and Swedish Krona.

The current portfolio is long the Aussie Dollar, New Zealand Dollar and British Pound and short the Japanese Yen, Swedish Krona and Swiss Franc:
Throughout the year, the weightings of each commodity component in the Index will naturally change based on changes in the underlying futures prices. The Fund's underlying holdings are rebalanced to the Index's base weights.

What I find particularly attractive about the index performance is that it has performed very well in tough years for the stock market and it only has one negative year on its record:


We are continually evaluating new ETF offerings, and this is another example of a fund that appears to offer good currency exposure for buy and hold investors with limited tolerance for volatility.

Emerging Market ETF Options

Vanguard's Emerging Markets ETF (VWO) is beatings its iShares rival (EEM) by 3.18% YTD. Vanguard's VWO is up 23.87% on the year, the MSCI EM Index is up 22.31% and EEM is up 20.89%. Since both funds supposedly track the same index -- the MSCI Emerging Markets Free index -- the high tracking error is bad news for both companies, but is particularly bad for iShares as investors typically are more accomodative if the tracking error leaves them ahead. The Vanguard fund has one other advantage, its expense ratio is 0.30% vs. 0.75% for the iShares fund. But, in spite of these apparent advantages the iShares fund is still 9.5 times larger than the Vanguard fund, proving once again that it is notoriously hard for ETF providers to make up ground on the market leader. We were early adopters of the iShares EEM ETF but are currently looking at VWO as a viable alternative.

The source of the difference may well be the allocation of each ETF to each emerging market country. If you look at the Vanguard fund you will notice that it has slightly more exposure to India, Russia, Brazil, Taiwan and South Korea and less exposure to Mexico, South Africa and China.


While I don't think that the VWO outperformance will necessarily persist, its low expense ratio is attractive. The iShares fund has to beat Vanguard's VWO by 45 basis points a year in order to overcome the difference. That alone may be a good reason for the switch. Since we usually supplement our MSCI EM exposure with country specific ETF's the specific country allocations become less important and the need to obtain cheap beta more important.

DXKSX: An ETF to Play Falling Treasury Prices

I have been tracking the Direxion 10 Year Note Bear 2.5X Inverse ETF (DXKSX) to monitor how well it does at tracking the upward yield pressure we have been predicting in the 10 Year Treasury note. So far the strategy appears to be playing out fairly well. The ETF is up over 11% since early March when I first started tracking it:


If the 10 Year Treasury yields continue their push towards 5.5% as we have predicted it is safe to expect that this ETF will continue to capture much of that return.

How much Australia Exposure do you have?

In the chart below I graphed the performance of 4 prominent Asian stock market indexes -- Japan, Malaysia, Hong Kong, Singapore -- and Australia over a 5 year period. If I had taken a survey to see if investors thought that the Asian countries or Australia was a better market to invest in over the past 5 years, I would bet that most retail investors would put their money on Asia. Here is the list from worst to best:

1. US - S&P 500 - 5.7% CAGR
   
2. Japan - DJ Japan - 11.91% CAGR
3. Malaysia - DJ Malaysia - 14.7% CAGR
   
4. China - DJ Hong Kong - 15.8%
5. Singapore - DJ Singapore - 19.2% CAGR
   
6. Australia - DJ Australia - 23.3% CAGR
   

So what is the lesson here? Well, for starters proper asset allocation hopefully gave each of you exposure to these and other emerging markets in your portfolio. If you didn't have adequate exposure to this area your returns have probably lagged over the past 5 years. Today with companies like iShares offering more and more invidual country ETF's you can get more precise exposure to countries that are well positioned for growth over the next 5-10 years. Even though Australia (EWA), Singapore (EWS) and Malaysia (EWM) have all been hot for some time I believe that all three will continue to benefit from the explosive growth of China and India. The downside of course is the volatility.

A Word of Caution: Country-specific ETF's are not for the faint of heart. Expect some sort of major emerging markets pullback in 2007 along the lines of that which we experienced in the summer of 2006. That pullback very well may be a good time to start developing a longer term emerging markets position.

An ETF Primer

For those of you who stay up to date on the financial markets I'm sure you have watched with wonder as ETF's have gone from obscure investment product to a position of relative prominence in the industry. For those of you not in the know perhaps a quick brush-up is in order.

An ETF, or an Exchange Traded Fund, has the following features:

1. ETF's are listed on an exchange and thus trade like a stock (High Liquidity)
   
2. When you buy one ETF you get access to a basket of securities (Diversification)
3. An ETF typically tracks an index or an intellidex, and as such it is not actively managed (well at least not yet . . .).
4. ETF's are tax efficient and have very low fees.

While this is by no means an exhaustive list of the traits of ETF's it should be enough for many of you to realize how advantageous these instruments can be for the average investor. In fact many of the top pro's (like Yale's David Swenson) in the industry are now recommending ETF portfolios to the average investor.

For years mutual funds were the standard way to get diversification in a portfolio. When you buy a mutual fund you pay a front end load to get in and then an annual management fee around every single year. The idea is you pay a smart money manager to manage your investments, benefit from being diversified and hopefully get better returns as a result.

One problem; mutual fund returns after expenses underperform the market. In all my reading I have yet to find an economics article in a peer-reviewed journal that has been able to convince me that mutual fund managers are able to "Add Alpha."

The solution: if you can lower your fees, create more tax efficiency and access markets that were previously inaccessible to the average investor, and do all of this using ETF's, it seems like a no-brainer. Unfortunately that isn't the end of the story.

ETF's have trading costs and can suffer from tracking error. They are not great for every investor. They are perhaps best for lump sum investors with a buy and hold philosophy rather than for those making systematic contributions or who actively trade.

I suggest you brush up on the basics using the following resources and we'll pick this up again next week. Feel free to fire off any comments/questions.

• Read the good news about taxes and the balanced view on taxes.

• Read about how well ETF's do at tracking their indexes.

• Read about how ETFs give access to new markets.