ETF XRAY

Japan (EWJ) Continues Weakness

By Carl Delfeld of Chartwell ETF

Japan has notched up five sequential quarters of decline. This is due to more than slipping demand from overseas. Orders from manufacturers, which tend to focus on exports, rose in May from the previous month. By contrast, orders from sectors such as construction and telecommunications which are a good proxy for domestic demand, fell 7 percent. This suggests continued significant excess capacity, the culprit of Japan’s economic dilemma. The world’s second-biggest economy has an output gap, on the government’s reckoning, in excess of 8 percent.

Light order books are a reflection of weak capital expenditure plans, as recently highlighted in Japan’s quarterly Tankan survey of business sentiment Government spending cannot fill the gap given Japan’s huge debt burden equal to 185% of GDP. Public sector orders dropped 11 percent month on month in May, although this followed a 22 percent increase in April.

Japanese equity markets and (EWJ) had fallen by midweek six consecutive days. Japanese loan growth is also decelerating, in part as companies and households grow more reluctant to borrow and spend. Corporate bankruptcies, meanwhile, continue to soar: more than 1,400 companies went bust last month, up 7 percent from a year ago.

 

Chartwell ETF Pick of the Week

By Carl Delfeld of Chartwell ETF

WisdomTree Dreyfus Emerging Market Currency (CEW)

Rationale and Overview:

This brand new emerging market currency ETF offers investors the opportunity to gain access to emerging market currencies such as Brazil, Chile, China, the Czech Republic, Hungary, India, Israel, Malaysia, Mexico, Poland, Russia, Singapore, South Africa, South Korea, Taiwan, Turkey, and Thailand.

Diversification into these emerging market currencies has the potential of helping your global portfolio in a number of areas, principally, higher yields, stronger economic growth leading to chances for appreciation, and exposure to non-correlated assets that will likely move opposite or contrary to equities and other asset classes. 

Emerging market equities react to factors independent of those factors that drive currency returns, often contributing to significantly higher volatility. Over the last 10 years, an equally weighted basket of emerging currencies had an annualized volatility of 6.9%, while an equally weighted basket of emerging market stocks from the same countries had a volatility of 25.2%.

Emerging economies often offer higher yields to compensate investors for these risks. The chart below uses global one-month deposit rates to present a range of yield opportunities available to U.S. investors in certain emerging and developed markets. The bar labeled “Emerging Basket” shows an average of the emerging market currencies shown. As of March 31, 2009, the average rate on the Emerging Basket was 3.6 percentage points higher than deposit rates on the euro and 4.2 percentage points higher than similar short-term rates in the U.S.

Catalyst: Emerging market equities have had a good run and the time is right to lighten up a bit by including some currency exposure. Investors are also looking for higher income and plays on a weaker US dollar.

Tip: Keep CEW as one your currency plays along with the Canadian (FXC) and Australian (FXA) dollar.

Risk Factor:
The risk factor is medium and I suggest an 8-10% trailing stop loss.

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Indonesia (IF) a Strong Performer

By Carl Delfeld of Chartwell ETF

Indonesia (IF) has been one of this year’s top performers. Indonesian President Susilo Bambang Yudhoyono outlined yesterday his domestic agenda for the next five years, predicting that if re-elected later this year Indonesia would record 7 per cent annual economic growth by 2014.

Analysts are paying close attention to Mr Yudhoyono’s forecasts because he is widely expected to defeat his two rivals in presidential elections to take place in July. Current polls suggest Mr Yudhoyono, whose Democrat Party won the most votes in April’s parliamentary election, will win comfortably in one round but experts believe his lead will narrow once the formal campaign begins next week.

Indonesia last experienced 7 percent economic growth in 1996, during the era of the dictator Suharto and before the 1997/98 Asian financial crisis. Growth last year was 6.1 per cent and 4.4 per cent in the first quarter of this year. Analyst forecasts for 2009 range from around 2 per cent to 4.5 per cent. The Asian Development Bank approved on Wednesday a $1bn standby loan to Indonesia, as the country puts together a $5.5bn  package to bolster its ability to navigate the global financial crisis.

The loan came as Bank Indonesia, the central bank, cut its benchmark rate by 25 basis points to a four-year low of 7 per cent to stimulate growth after inflation reached a 17-month low of 6.04 per cent, year-on-year, in May.

Receive more information on Indonesia and Asian and emerging markets by going to Chartwell ETF.

Top Ten Global ETFs

By Carl Delfeld of Chartwell ETF

Hundreds of international and global ETFs are listed on the exchanges. However not all of them are able to attract significant amount of assets. The following are the top 10 global ETFs by Total Net Assets:

iShares MSCI Emerging Markets Index (EEM)

iShares MSCI EAFE Index (EFA)

iShares FTSE/Xinhua China 25 Index (FXI)

Vanguard Emerging Markets Stock ETF (VWO)

iShares MSCI Brazil Index (EWZ)

iShares MSCI Japan Index (EWJ)

Vanguard Europe Pacific ETF (VEA)

Vanguard FTSE All-World ex-US ETF (VEU)

iShares MSCI Taiwan Index (EWT)

iShares MSCI Pacific ex-Japan (EPP)

EEM and EFA have assets of $30.7B and $30.2 B respectively as of June 19,2009 making them the largest two international ETFs. Nearly half of the top 10 ETFs are related to emerging markets. This shows that investors are betting heavily on emerging markets this year. EEM, the largest emerging market ETF is also one of the largest traded ETF in the NYSE on a daily basis.

Overall, EPFR Global-tracked equity funds posted inflows of $508 million for the week as flows into emerging markets and Global Equity Funds offset modest outflows from US, Japan and Europe Equity ETFs and Funds. 

Using Options to Hedge an ETF Portfolio

By Carl Delfeld of Chartwell ETF 

Many ETF investors are unaware that roughly 40% of ETFs have options that can be used to hedge positions, take advantage of leverage or straddle markets to bet on volatility. For some ETFs, option maturities go out as far at January 2011 and, in November, the January 2012 options will hit the market.

The easiest way to find out if options are available for a specific ETF is to go to Yahoo Finance and put in the ticker. On the left side will be a menu. Just click on the “options” link and, if options are available, they will come up for review.

Before jumping into options trading, you should consult with your financial advisor and do some research as to the basics. You can keep it simple like checkers, or get a bit more sophisticated like chess.  

A good place to start may be brushing up with options basics from Investopedia, including definitions of some key terms like call options and put options.

Hedging a long ETF position

One of the simplest uses of options is to use it to hedge a long ETF position. For example, I have in the past discussed in Chartwell ETF how to use a put as “China insurance”.

Suppose that you think China (FXI) will go up but you are uncomfortable with the downside risk that goes along with investing in China. You go purchase FXI and at the same time purchase an FXI put option (right to sell) with an expiration date in January 2011. The cost of this is the “premium” which will depend on what “strike price” you choose. If the FXI goes up more than the price of this premium, you will make a profit. If FXI goes the wrong way, you loss will be somewhat offset by the put option in place. I refer to this as a portfolio “shock absorber”.

Covered Calls

This well known conservative strategy can increase your returns. But perhaps the simplest way to execute this strategy is using ETFs that do it for you. There are two possibilities. Two of the best-known buy/write ETFs are IQ Investor Advisors' S&P 500 Covered Call Fund (BEP) which is a closed-ended fund going back to March 2005 and the PowerShares' S&P 500 BuyWrite Portfolio (PBP) that was launched in late 2007. Both seek to track the CBOE BuyWrite Monthly (BXM), an index based on a covered call strategy for the S&P 500.

The ETF Straddle

Sometimes an investor faces a situation of great uncertainty and volatility. Banks in early 2009 would be a great example of this environment. No one new if they would go up 50% or down 50% as a sector. An investor could take advantage of this dilemma buy buying both a put and call option at the same or different strike prices. If the underlying banking sector ETF goes up or down by more than the combined premiums, it will turn into a profitable trade.

Naked Call or Put

There are some strategists that believe buying call (right to buy) options is always preferable to purchasing the stock or ETF on a cash basis.

Let’s look at one example and see why. If you wish to invest in 100 shares of Brazil (EWZ) at a price of $50 your total cash outlay and exposure is $5,000 excluding commissions. However, the price of a January 2010 call option on EWZ at the $50 strike price is just $6 meaning you can have the option of buying 100 shares of EWZ for a premium of $600. You could lose all of the $600 if EWZ goes and stays below $50 through January 2010 but that is all you can lose.

Your $5,000 exposure to EWZ in the cash scenario is totally exposed and theoretically could go to zero.

Deep Naked Call or Put 

Sometimes if you have a deep conviction or gut feeling that an ETF is going in one direction because it is very much undervalued or overpriced, a deep out-of-the-money call or put may work. This is definitely speculation since if the ETF or stock moves the opposite way or even if it moves in the right direction but not forcefully, you will probably lose all your premium. I call this a “swing for the fence” strategy with the commensurate risk of striking out. At least all your friends won’t be watching.

An example of this situation was earlier this year when many international markets had fallen 50%-70% from they 2008 highs and looked incredibly cheap. There was a high likelihood that they would come back but when was basically anyone’s guess. I bought some January 2011 deep out-of-the-money calls on a few country-specific ETFs and posted some incredible returns due to the leverage inherent in such a strategy. I have also done this with (TBT) that moves inversely to the long Treasury bond on the assumption that long-term rates will have to increase in order to attract the financing that goes with our explosion in federal spending.

ETF options poise special risks but the leveraged rewards and the ability to use them to manage risk may make them an effective tool for some. For more advice on how to build and hedge a global ETF portfolio, go to ChartwellETF.