Can China ETFs Continue Their Ascent?

China ETFs’ recent gyrations are enough to give one whiplash. Many have behaved like the Shanghai Composite Index recently. After soaring 152% over the previous 12 months — 60% this year alone — to a seven-year high on June 12, the benchmark for mainland China’s stock market hit a significant speed bump.

Last week the index stumbled 13% into a much-anticipated correction. A 5% rally the first three days of this week gave way to selling Thursday, cutting the week’s gain so far to 1%.

“The sheer increase in prices this year is something that makes me want to stand back,” said John Rutledge, chief investment strategist for Safanad, an investment house in New York. “I don’t know any fundamental reason why prices should have doubled this year, and that price behavior sounds like a bubble.”

Rutledge is referring to the fact that the Chinese economy’s growth rate has slowed to a six-year low of 7%. But if fundamental analysis can’t explain it, macroeconomics can. With central banks all over the world cutting interest rates, there is flood of liquidity looking for returns.

The first thing to know is that there are two markets in China. The Hong Kong market, which has long been open to global investors, trades what are known as H-shares. Then there are the mainland markets in Shanghai and Shenzhen. They trade A-shares, which had been limited to domestic investors.

But last year the Shanghai and Hong Kong markets created a system that let global investors buy A-shares and domestic investors buy H-shares. This change has brought a lot of money to the mainland markets.

On top of that, the People’s Bank of China, the country’s central bank, has cut interest rates three times since November, and more cuts are expected.

Finally, throw in a slowdown in the Chinese real estate market. It led the Chinese government to encourage investments in stocks by making it easier for Chinese retail investors to open accounts and buy stocks on margin.

Loss Of Liquidity

And a loss of liquidity sparked last week’s correction. First, Chinese regulators, worried that the market was getting overleveraged, tightened the rules on margin trading. Then a slew of initial public offerings sucked up a lot of cash.

There’s no doubt that China is risky. But gains could resume if the economy picks up and government stimulus programs continue. And index provider MSCI is evaluating A-shares for inclusion in its emerging markets index. That could spark demand by many funds that track MSCI indexes.

If you want China A-Shares in your portfolio, investing in ETFs is the way to go. KraneShares offers four ETFs focused on China. Its Bosera MSCI China A ETF (ARCA:KBA) holds more than 300 large-cap and midcap stocks on both the Shanghai and Shenzhen stock exchanges.

KraneShares says that these are the stocks that would be included in an MSCI emerging markets index. KBA is up 40% year to date and 126% in the past 12 months. It has an expense ratio of 0.85%.

Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ARCA:ASHR) tracks the CSI 300 Index, which holds the largest and most liquid stocks in the A-share market. It’s up 35% year to date and 129% for the past year. It charges 0.8% of assets for expenses.
Market Vectors ChinaAMC A-Share ETF (ARCA:PEK) also tracks the CSI 300 index but charges less: 0.72%. It’s up 39% year to date and 132% in the 12 months. The big difference is that ASHR is more liquid and offers a 0.2% yield, while PEK offers none.

As liquidity improves in July, David Goldman, managing director of investment firm Reorient Group, sees a market recovery and a move back up beyond the 5,000 level for the Shanghai Composite.

“Economic fundamentals are clearly improving, and so are regulatory incentives for stock market growth,” he wrote this week.

Originally published in Investor’s Business Daily.

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Investor cash pours into Hong Kong ETFs

All this talk about a bubble in the Chinese stock market isn’t scaring away investors from flooding the largest exchange-traded funds that track Chinese stocks with bucket loads of cash.

April saw HK$20.5 billion ($2.6 billion) flow into the Hang Seng H-Share Index Fund (SEHK STOCK CODE 2828). It was the largest monthly inflow since 2010 and the third-most among equity ETFs globally, according to data compiled by Bloomberg.

The Hang Seng H-share ETF holds the stocks of 40 of China’s biggest state-owned companies. Financials make up 67% of the portfolio. The fund is valued at about 10 times forward earnings, compared with the 17 multiple on the Shanghai Composite Index, according to Bloomberg.

The ETF’s shares rose 17% last month to HK$145.20, its third consecutive month of gains. Over the past four months, the ETF has received a total of HK$29 billion, its longest stretch since 2013. Total assets grew to HK$57.1 billion.

The U.S.-listed iShares China Large-Cap ETF (FXI) received $385 million last month, the biggest inflow in eight months. It jumped 16% in April, for a 51% return over the past 12-months.

One big reason for the rally is that Chinese companies trading in Hong Kong are priced at a significant discount to their dual-listed counterparts on the mainland. UBS said even though the Hang Seng China Enterprises Index leapt 17% in April, its largest jump since October 2011, Chinese A shares still trade at a 31% premium to Hong Kong stocks.

Investors are betting on more monetary easing in the world’s largest economy.  Since the November Shanghai-Hong Kong exchange link opened mainland stocks to foreign investors, mainland stocks have seen a flood of inflows. In addition, the People’s Bank of China has cut interest rates and reduced banks’ reserve requirement ratios twice in the past six months, sending more liquidity into the markets. Another rate cut is expected soon.

Over the past year, the Hang Seng China Enterprises benchmark soared 48% vs. the 119% surge of the Shanghai Composite Index’s A shares.

Originally published in Asia Times.

Comparing ETFs? Don’t Just Look At Expense Ratios

The rule when buying ETFs is that when all things are equal, buy the one with the lowest expense ratio. But remember that similar sounding ETFs often aren’t equal. This means don’t let the expense ratio be the only factor in choosing an ETF.

“Our belief is expenses and past performance matter, but more important is understanding what’s inside the portfolio,” said Todd Rosenbluth, S&P Capital IQ director of ETF research.

SPDR S&P 500 ETF (SPY) tracks the S&P 500 stock index and charges a tiny expense ratio of 0.09%, commonly called nine basis points. One hundred basis points make up 1 percentage point. Guggenheim S&P 500 Equal Weight ETF (RSP) also tracks the S&P 500. But it charges a fee of 0.4% of assets.

Look At The Performance

“You might ask ‘Who in their right mind would pay 40 basis points vs. 9?'” said Ron Delegge, founder of ETFguide. “But then you take a look at the 10-year return.”

RSP returned an average annual 9.42% in the past 10 years, compared with 7.85% for SPY, according to Morningstar. In fact, RSP beats SPY in all periods reported on Morningstar.com, from one month on.

The big difference between the funds is the way the indexes are weighted. SPY follows the S&P 500’s classic market-capitalization weighting, which multiplies the stock price by the number of shares outstanding to get a stock’s market value. The biggest companies get a larger weighting, comprising a greater percentage of the index than the smaller ones. Thus a $1 move in Apple (AAPL), with a 3.98% weighting, will lift or drag down the index much more than a $1 move in the shares of Diamond Offshore Drilling (DO), which has a weighting of just 0.01%.

But RSP gives every stock in the index an equal weighting of 0.2%. This means a $1 rise in Diamond Offshore’s stock moves the index just as much as a $1 increase in Apple’s shares. By giving greater weight to the smaller stocks in the index, this has a big effect on the fund’s performance. Year to date, RSP is up 2.25% vs. SPY’s 1.29%, 96 basis points more — after paying the expense ratio.

“Would I be willing to pay more for those returns?” asks Delegge. “Definitely.”

Of course, SPY could just as easily outperform RSP in periods when the market favors large-cap stocks or other factors that can be found in SPY but not RSP.

But S&P 500 trackers aren’t alone. “One example that is much maligned is PowerShares FTSE RAFI U.S. 1000 ETF (PRF), said Michael Krause, president of AltaVista Research in New York, which runs the ETF Research Center website. “I calculate that cumulative since its inception in 2006, PRF has outperformed iShares Russell 1000 ETF (IWB) by 14 percentage points.”

ETF Research Center pegs PRF’s average annual return since 2006 at 8.9% vs. 8.1% for IWB.

PRF’s expense ratio is 0.39%, while IWB charges 0.15% of assets.

Not Alone

This trend happens a lot among the industry ETFs. SPDR S&P Homebuilders ETF (XHB) and iShares U.S. Home Construction ETF (ITB) sound like they track the same industry, meaning they should post similar results. XHB charges 0.35%, while ITB charges 0.45%, so XHB seems like a better choice.

Yet only 35% of the XHB holdings are actual homebuilding companies, and 28% building products. The rest of the stocks are home furnishing producers and retailers, home improvement retailers and household appliance makers. However, homebuilding companies make up 71% of the ITB portfolio, with building products at 13%.

ITB has risen by an annual average of 25.72% in the past three years vs. 21.01% for XHB. Year to date, ITB is up 8.32% vs. XHB’s 6.74%. That more than compensates for the extra 10 basis points.

“Cheaper hasn’t been better as of late,” said Rosenbluth.

Originally published in Investor’s Business Daily.

WisdomTree Wins ETF of Year at ETF.com Awards As ProShares Walks Away With 4 Statues

It’s award time again.

Much like Spring follows Winter, although reports of more snow this weekend are leading some to question that, the ETF industry starts its period of self-congratulations on the heels of the Oscars, Grammys and Golden Globes.

ETF.com, the self-proclaimed world’s leading authority on exchange-traded funds, started the season off with their second annual awards banquet.

“Our awards try to recognize the products that make a difference to investors,” said Matt Hougan, president of ETF.com. “The ones finding new areas to put money to work.” The awards are determined by a panel of experts chosen by ETF.com.

Held at The Lighthouse restaurant at New York’s Chelsea Piers March 19, ETF.com wins the prize for best party location. With picture windows overlooking the Hudson River, guests of the cocktail hour took in the sunset over New Jersey before the ceremony started.

The WisdomTree Europe Hedged Equity (HEDJ) was the big winner, grabbing the prize for ETF of the Year, while the Market Vectors ChinaAMC China Bond (CBON) won Best New ETF. Not quite sure what the difference is between those two awards, but obviously both funds stand out from the crowd of 117 ETFs issued in 2014.

However, ProShares swept the evening, as the single provider that won the most awards. The twin funds ProShares CDS North American HY Credit (TYTE) and CDS Short North American HY Credit (WYDE) claimed the awards for both Most Innovative New ETF and Best New Fixed-Income ETF.

“We designed these ETFs for investors who want high yield credit exposure that is isolated from interest rate risk,” said Steve Cohen, ProShares managing director.

The fund was also nominated for Best Ticker of the Year with its homophones for “tight” and “wide”. However, the awards announcer had a chuckle by claiming they really were pronounced “tighty whitey”, a reference to his jockey shorts. Best Ticker was awarded to HACK, the PureFunds ISE Cyber Security ETF.

ProShares also won Best New Alternative ETF for the ProShares Morningstar Alternative Solution (ALTS) and Most Innovative ETF Issuer of the Year.

“We are always striving to deliver new and innovative products to allow investors to build better portfolios,” said ProShares Chief Executive Michael Sapir.

Lee Kranefuss, the man who created the iShares brand of ETFs and built them into the largest ETF issuer in the world won the 2014 Lifetime Achievement Award.

In the only speech of the night — thank goodness — Kranefuss said, “ETFs allow people to take control.” He likened ETFs to iTunes, saying “no longer are you limited to what the record company puts out.” He said he’s often been asked if he thought the ETF industry would take off like it has in the 15 years since iShares launched.

“Not really,” said Kranefuss, “we just put out the best products we could put out.”

The other award winners:

Best New U.S. Equity ETF – iShares Core Dividend Growth (DGRO)
Best New International/Global Equity ETF – Deutsche X-trackers Harvest MSCI All China Equity (CN)
Best New Commodity ETF – AdvisorShares Gartman Gold/Euro (GEUR) and AdvisorShares Gartman Gold/Yen (GYEN).
Best New Asset Allocation ETF – Global X /JPMorgan Efficiente (EFFE)
ETF Issuer of the Year – First Trust
New ETF Issuer of the Year – Reality Shares
Index Provider of the Year – MSCI
Index of the Year – Bloomberg Dollar Index
Best Online Broker for ETF-Focused Investors – TD Ameritrade
Best ETF Offering for RIAs – Charles Schwab
Best ETF Issuer Website – BlackRock

Fed Ready? New Sit ETF Hedges Hikes In Interest Rates

Nobody should invest in bond exchange traded funds without understanding that when interest rates increase, the bond’s price declines. With significant improvements in the economy and unemployment rate, the Federal Reserve is expected to raise rates before 2015 ends. This will affect securities across the entire bond market.

So, what is a bond ETF investor to do? A new exchange traded fund from ETF Managers Group seeks to help investors hedge rising interest rates by using a concept called negative duration that actually creates price appreciation when interest rates advance.

Sit Rising Rate ETF (RISE) holds a portfolio of futures and options contracts weighted to achieve a targeted negative 10-year average effective portfolio duration. Because it holds futures, the ETF is structured as a commodity pool.

Sam Masucci, founder and chief executive of ETF Managers Group, said the ETF should be used as a hedge, or insurance, to protect a bond portfolio from interest-rate volatility. “A small allocation of 10% to 20% in RISE can significantly reduce the interest rate risk within a bond portfolio.”

Duration calculates a bond’s sensitivity to interest-rate volatility. It measures how much the price of a bond is expected to fall when interest rates rise 1% — and rise when rates fall 1%. The longer the duration, the greater the interest rate risk. Negative duration determines how much the price will go up when rates rise. RISE tries to get a 10-to-1 ratio. So if rates rise 1%, the price should go up about 10%.

Bryce Doty, the senior fixed-income portfolio manager at Sit Investment Associates, manages the ETF based on the Minneapolis firm’s strategy.

Where RISE Fits In

Doty said an investor with a bond portfolio with an average duration of four years might choose to sell 20% of the portfolio and invest that money in the negative 10-year duration ETF. This cuts the interest rate risk by almost 70%.

The ETF achieves this effect by holding only four positions. Focused on the risk to short-term rates, 85% of the ETF’s portfolio is in short positions tied to 2-year U.S. Treasury and 5-year U.S. Treasury futures contracts. It also buys a put option on the 10-year U.S. Treasury futures contract. This means if rates rise on the 10-year note, the ETF gets price appreciation. But if rates fall, the EFT is only out the price of the put.

Compared with bond index ETFs, which typically charge expense ratios of less than 10 basis points, RISE, which is an active ETF, charges an expense ratio of 50 basis points. With other expenses factored in, the true cost can rise as high at 1.5%, although the fund is targeting a cost around 85 basis points.

“When you rebalance every month and short new Treasury futures to get target duration, you might get a tax hit at the end of the year,” said Thomas Boccellari, an analyst at Morningstar. “The benefit of the active management is, you pay the manager to control the duration for you and to get it right. But you need to understand that you are giving up a lot of yield to get this product and you need to be sure that is what you want to do.”

Two negative duration ETFs tracked by ETF.com are WisdomTree Barclays U.S. Aggregate Bond Negative Duration Fund (AGND) and WisdomTree BofA Merrill Lynch High Yield Bond Negative Duration Fund (HYND) has $32 million in assets, average daily volume of about 11,000 shares, an expense ratio of 0.28% and is up 0.44% year to date. HYND has $6.5 million in assets, average daily volume of about 9,000 shares, a 0.36% expense ratio and is up 2% this year.

Originally published in Investor’s Business Daily.

DoubleLine Joins State Street On Active Bond ETF

ETF giant State Street Global Advisors teamed up with DoubleLine Capital, the firm of famed bond investor Jeffrey Gundlach, to launch SPDR DoubleLine Total Return Tactical ETF (TOTL) last week.

The actively managed ETF is DoubleLine’s first foray into the ETF space.

One of the most respected bond fund managers in the market, Gundlach ran $12 billion TCW Total Return Bond Fund until 2009. At the time, Morningstar said it was in the top 1% of all funds invested in intermediate-term bonds for the five years ended in 2009.

Gundlach left TCW after a management dust-up and formed DoubleLine in 2010. He’s DoubleLine’s CEO and chief investment officer.

“It’s not a clone of any existing strategies,” said Jeffrey Sherman, a DoubleLine portfolio manager, during a webcast this week. Sherman will co-manage the ETF with Gundlach and firm President Philip Barach. “It’s a new product created just for this offering, but it draws upon the views of Jeff Gundlach and the DoubleLine team.”

While not identical to the firm’s flagship DoubleLine Total Return Bond Fund , ETF investors will be getting a deal. The ETF charges an expense ratio of just 0.55%, compared with the fund’s 0.72% fee for retail investors.

By going with a name-brand fund manager, State Street (NYSE:STT) is making a calculated effort to take advantage of the problems at Pimco. It looks like it wants to become the leading bond ETF in the country by taking on $2 billion Pimco Total Return Bond ETF (BOND).

BOND has seen more than $1 billion in outflow since Bill Gross, Pimco’s bond maven, left the firm in September. This caused BOND to fall to second-largest active bond ETF.

TOTL’s investment objective contains elements of both DoubleLine’s total return and core fixed-income strategies. The ETF aims to have a low interest-rate risk profile.

At the same time it expects to maximize returns through active allocation and selection of securities its analysis determines to be mispriced in the market.

DoubleLine Total Return Bond Fund has focused on mortgage-backed securities. But the ETF can hold any bond, including U.S. Treasuries, investment grade corporate credit, high-yield bonds, collateralized loan obligations, asset-based securities, bank loans and sovereign debt from both developed and emerging markets.

The portfolio must contain a minimum of 20% in mortgages, but it isn’t required to hold anything else. While high-yield, emerging market and CLO securities can each only take up as much as 25% of the portfolio, as much as 85% can be held in government bonds.

The duration of a single bond can range from one to eight years and no security can have a bond rating below BBB-.

State Street Getting Active

State Street, which has a reputation for running passively managed funds, has slowly moved into the active ETF arena. The new fund is its third active bond ETF and 10th overall.

While active equity funds have a hard time beating their benchmarks, the less transparent bond market creates more opportunities for managers to beat their index.

“Passive does best in U.S. equities, but in investment grade fixed-income 65% of managers outperform their benchmark,” said Dave Mazza, head of research at SPDR ETFs. “A skilled fixed-income portfolio manager can find inefficiencies across the market because it is illiquid and opaque.”

Exec’s Departure Latest In Pimco’s Bad Year

Paul McCulley’s announcement last week that he would be stepping down as chief economist at Pacific Investment Management Co. was just the latest note in the giant bond fund company’s annus horribilis.

Early last year, Chief Executive Mohamed El-Erian, Pimco’s heir apparent, left over disagreements with Bill Gross, Pimco’s founder and portfolio manager of the firm’s flagship Total Return Fund . At the time, Total Return was the largest bond mutual fund in the world and Gross the most famous bond investor on the planet.

Then in September, after the fund shrank by $65 billion over the previous 16 months, Gross also abruptly quit, shocking the mutual fund world and sending Pimco into turmoil. He’s now at Janus.

McCulley, a close friend of Gross, had left Pimco in 2010, but returned in May to help Gross calm investors’ nerves amid the outflow.

“McCulley had been brought in by Gross when things were unraveling in the management ranks,” said Jeff Tjornehoj, head of Lipper Americas Research. “Bringing Paul in was like bringing the band back together. He came back so Bill could show ‘It’s not as bad as the newspapers say.'”

With Gross’s departure, there wasn’t much reason for McCulley to stay, and management made that clear with the recent hiring of Joachim Fels, Morgan Stanley’s chief economist, as the new global economic adviser.

New Pimco Team

In the wake of Gross’s departure, Daniel Ivascyn, who has been at Pimco since 1998 and is head of the mortgage credit portfolio team, was named group chief investment officer. In 2013, Morningstar named him Fixed-Income Fund Manager of the year.

Pimco also named deputy chief investment officers Mark Kiesel, Scott Mather and Mihir Worah as portfolio managers of Total Return Fund.

Kiesel, named Morningstar’s Fixed-Income Fund Manager of 2012, is the global head of corporate bond portfolio management with oversight for the firm’s credit research. Mather was previously head of global portfolio management, and before that led portfolio management in Europe.

Before running the real return and multi-asset portfolio management teams, Worah was a postdoctoral research associate at the University of California, Berkeley, and the Stanford Linear Accelerator Center.

In the four months since Gross left, Pimco said, the fund delivered a net after-fee return of 3.99%, outperforming its benchmark by 1.11 percentage points.

Will Inflow Follow?

“The strong performance of the Total Return Fund since Scott Mather, Mark Kiesel and Mihir Worah took over management of the fund is a reflection of the talent of our seasoned portfolio management team,” said Douglas Hodge, Pimco’s CEO, in a statement January.

Still, it doesn’t look like the new team is instilling much confidence in investors. January was the 21st consecutive month of withdrawals, with net outflow of $12.5 billion, although this was significantly lower than the $32.3 billion pulled out the month after Gross left, according to Morningstar. Over the past 21 months, Total Return Fund lost $159.3 billion in net assets, down 54% from its 2013 peak of $293 billion, according to Morningstar. It is now the world’s second-largest bond fund.

For the full story go to Investor’s Business Daily.