ETF XRAY

Record IPO Flow Helps BRIC ETFs

Carl Delfeld of the Chartwell ETF Advisor

Petro-China, the state-owned oil and gas group, launch of a listing in Shanghai in a deal that raised more than $9bn was just the tip of the iceberg of recent BRIC country IPOs. This is good news for exchange-traded funds that track the markets of Brazil, Russia, India and China as well as other emerging markets.

Joanna Chung of the Financial Times reports that nearly half of the $57bn raised globally by IPOs in the latest quarter was by companies in the so-called “Bric” countries of Brazil, Russia, India and China, which produced a record 118 IPOs.

Seven out of the top 10 IPOs in the third quarter were from emerging markets. The Asia-Pacific region, and in particular, China and Hong Kong – had the major share in terms of both the number of IPOs completed as well as the money raised.

The exchange-traded funds that track BRIC countries as a group are as follows:

Claymore/BNY BRIC (Brazil, Russia, India, China) ETF (EEB)
SPDR S&P BRIC (Brazil, Russia, India, China) 40 ETF (BIK)

Which of the BRIC countries should be in your portfolio? The Chartwell ETF Advisor is positive on two, hates one and believes that the other is overvalued.

Russia Grabs Pole Position, China Gains, in Emerging Markets ETF

Russian companies, fueled by the rapid growth and profitiability of its energy sector, have risen the ranks of the top ten companies in the emerging market index and the exchange-traded funds that track it such as (EEM).

The top ten holdings in this ETF basket in order of weighting are:

Gazprom (Russia)
Samsung Electronics (South Korea)
Posco (South Korea)
Taiwan Semiconductor (Taiwan)
Kookmin Bank (South Korea)
Silicon Precision (Taiwan)
Lukoil Holdings (Russia)
Chungwa Telecom (Taiwan)
China Mobile (Hong Kong)
United Microelectronics (Taiwan)

It may be surprising to many investors to see Taiwan with four out of the ten top holdings. China is also making progress and in the MSCI World index has pulled even with Taiwan and has also matched Hong Kong in terms of country weighting.

PetroChina announced today it would launch one of the biggest ever initial public offerings on the mainland market, becoming the latest large state-owned company to seek a Shanghai listing. The oil and gas group said it would issue up to 4bn shares in Shanghai which at Tuesday share price in Hong Kong, where it is already listed, would raise around $5.7bn

By Carl Delfeld of the Chartwell ETF Advisor

Is India Economy and ETF Too Hot?

Fears that India's economy, stock market and the exchange-traded fund (INP) that tracks it are overheated led its central bank to ramp up interest rates. Since January 2006 the Reserve Bank of India (RBI) has raised its overnight lending rate by one and a half percentage points, to 7.75% and the rupee, in turn, has jumped 10% in value versus the US dollar duringn the past four months alone.

But rather than slowing down, India's economy is speeding up. An article in the Economist states that JPMorgan estimates that growth in the three months to March accelerated to a seasonally adjusted annual rate of 11.4%. Yet, despite rapid growth, wholesale-price inflation fell to 5.1% in mid-May, down from 6.7% in January. Still the signs of an overheated economy are everywhere. A sharp increase in house prices, credit growth of 28% over the past 12 months, 15%-plus average rises in wages for skilled workers, record industrial capacity utilisation rates, and 41% more imports in April than a year ago.

Plus, consumer prices still appear to be rising at an annual 8% clip which likely means that more aggressive rate hikes are on the way. The trick is to slow growth down a bit without triggering a sharp decrease in economic activity - easier said than done and what in the US is often referred to as a soft landing.

The higher rupee has helped boost returns for investors in the India ETF but valuations may be getting a bit toppy. Still you must admire the underlying growth and momentum of the Indian economy. Will higher interest rates and a stronger currency blunt this mojo?

Join the Chartwell ETF Advisor and stay on top of the India story.

Latin American ETFs Gain, China Suffers Negative Flows

Investors continued to reduce their direct exposure to Chinese equities and exchange-traded funds during the first week of June, pulling over $1 billion out of China and Greater China Equity Funds tracked by
EPFR Global for the second week in a row. But they pumped another $810 million into Latin America Equity Funds, adding to their indirect bet on the Chinese economy’s robust growth and its demand for raw materials. ETFs and funds geared to developed markets had a mixed week. Japan ETFs and equity funds extended their losing streak. But US equity funds posted inflows on the strength of an exceptionally good week for Large Cap Growth Funds as interest rate fears took a brief holiday before resuming at mid week, European equity funds were back in the black and global equity funds and ETFs extended their winning streak to 13 straight weeks.

There was a strong suggestion in this week’s data that investors are looking for dips to buy into. Flows and fund performance were, for the most part, inversely correlated. The four equity fund groups that posted the best portfolio performance – Japan, Pacific, EMEA and Asia ex-Japan equity funds – all posted net outflows, while relative laggards such as European, Global and Latin America equity funds attracted fresh money.

At the country level Brazil has been the star in recent weeks. But Mexico Equity Funds took in $149 million during the week ending June 6, handily distancing Brazil Equity Funds in terms of flows as a percentage of assets under management.

Find out more by joining the Chartwell ETF Advisor

India Market Passes $1 Trillion Milestone

The India stock market, helped by its largest companies which play a key role in the performance of its exchange-traded fund (INP), passed the historical mark of surpassing $1 trillion in market value.

According to the Bombay Stock Exchange, the total market capitalisation of India's stocks this week reached Rs40,811bn or $1,009bn with the rupee trading at Rs40.45 to the dollar, market capitalisation at the close was $1,009bn. The Financial Times reports that The Bombay Sensitive Index, a basket of 30 large and liquid stocks, yesterday closed up 110 points, or 0.77 per cent, at 14,508. It has trebled in three years.

The exchange is now the 14th largest in the world but a recent Morgan Stanley study offerd a cautionary note since big stocks contributed most of the returns. Surprisingly, two-thirds of stocks have shown negative returns in the past 12 months. "India is likely to under-perform its peer group due to concerns on inflation and hence growth," Morgan Stanley said. "The absolute direction of the market is still a function of global risk appetite."

By Carl Delfeld of the Chartwell ETF Advisor

Brazil Beats China for Fund and ETF Investment Flows

During the last week in May, investment flows into emerging markets by global equity managers and exchange-traded funds tracked by EPFR Global tilted toward Latin America and in particular Brazil at the expense of China.

The $789 million that investors committed to Latin America funds and ETFs was driven in part by a reassessment of Brazil’s economic prospects following its latest ratings upgrade. That upgrade, allied to falling interest rates and the government’s willingness to at least entertain the idea of rationalizing Brazil’s tax system, point to some positive surprises from the region’s biggest economy during the second half of the year. Brazil equity funds took in $280 million, their best showing in percentage terms since the last week of January, 2006. But investors still expect some negative surprises from the biggest economy in the Asia ex-Japan universe: they pulled another $354 million out of China and Greater China funds as the Chinese government continues its effort to rein in the country’s red hot economy and its booming equity markets.

In addition, EPFR Global reports that year-to-date flows into Emerging Markets bond funds pushed over the $3 billion mark. Global and Pacific Equity, Utilities Sector and High Yield Bond Funds also extended their winning runs as the spread between US Treasuries and JP Morgan’s benchmark EMBI+ index narrowed to a new record low of 153 basis points. But China and Japan Country funds and ETFs remained out of favor, although the pace of outflows slowed somewhat, and funds geared to interest rate sensitive sectors were hit with further redemptions.

By Carl Delfeld of the Chartwell ETF Advisor

China ETF is not a Bubble?

While the Shanghai A-share index stood at 4,375 on May 23rd representing a 258% gain since the beginning of 2006; the China exchange-traded fund (FXI) made up of primarily H shares listed on the Hong Kong Stock Exchange is up less than 5% so far this year.

The Economist points out several reasons why the Shanghai market may not be a bubble after all. First, it looks at the valuation issue. Chinese shares certainly look expensive, with an average price-earnings ratio of almost 50 (based on historic profits). But p/e ratios are hard to interpret when profits are growing so strongly. Over the past decade China's p/e ratio has averaged 37, much higher than elsewhere. According to Goldman Sachs, firms listed on the A-share market enjoyed an average 82% increase in profits in the year to the first quarter. The article also notes that since 2003, Chnia has been the laggard of the four BRIC countries even with the rapid rise over the last year.

Next, it looks at the likely impact of a sharp pullback in China's market. The total value of tradable shares—that is, excluding those held by the government—is only 25% of GDP (the market capitalisation is nearly 80%). This compares with 150% in America and over 100% in India. Some estimate that only 7% of Chinese hold any shares at all compared to 50% plus in America. But this is changing fast as more than 300,000 new brokerage accounts are opened in China every day!

What is interesting is whether you can now buy H shares in Hong Kong at lower multiples for the same company that trades for on the Shanghai or Shenzhen market. This is certainly something worth looking into.

By Carl Delfeld of the Chartwell ETF Advisor

Russian ETF Primarily Energy Play

Tne new Russian exchange-traded fund (RSX) introduced by the Van Eck family of ETFs is decidedly an energy play. RSX tracks the DAXglobal Russia Index, which holds 30 companies based in Russia and attempts to represent the Russian economy broadly. RSX is very exposed to energy companies, accounting for over $150 billion of exports in 2006. Backtested the DAZglobal Index has yielded a 5-year annualized performance of about 40% .

This dependence on energy cuts both ways of course but keep in mind that politically Russia may present global ETF investors with more risk than other BRIC countries. Russia will also be watched closely as it elects new leadership in early 2008.

Jonathan Bernstein of ETFzone points out that only one company in the top eight holdings of RSX is not an energy company. This is Sberbank which is heavily involved in energy lending. A quick glance shows that almost 50% of the RSX basket is accounted for by the largest seven energy holdings. Still, RSX is far superior in terms of cost and flexibility to previous Russian funds on the market and has an annual fee of only 0.69%.

By Carl Delfeld of the Chartwell ETF Advisor

China, Japan ETFs Rebound After Weak Start

Despite measures by the People’s Bank of China last Friday such as raising interest rates and lifting bank reserve requirements, both intended to suck out liquidity cool hot share prices, the Shanghai Composite finished today up 1% after falling 3% in early morning trading.

The Central Bank also widened the trading band for the renminbi just days before Beijing ministers headed for the US for a meeting at which their management of the allegedly undervalued currency would be a focus of discussion. But the Financial Times reports that the widening of the daily trading limit to 0.5 per cent would have no direct implications for the renminbi’s level against the dollar, since the currency has rarely come close to testing the 0.3 per cent limit set in 2005. The the pace of renminbi appreciation has actually slowed in recent months, to an annual rate of about 2 per cent.

Japanese shares also headed higher on Monday, buoyed by continued yen weakness. The Nikkei 225 gained 0.9 per cent to close at 17,556.87 while the broader Topix was up 0.9 per cent at 1,710.67.

By Carl Delfeld of the Chartwell ETF Advisor

Emerging Market ETF Snapshot

The emerging market countries and the exchange-traded funds that track them are playing an increasingly important role in the global economy and our global ETF portfolios.

Emerging market countries account for 85% of the world's population, 25% of world GDP and the Deutsche Bank estimates that they will generate 50% of global growth in 2007. During the last four years, emerging market countries had GDP growth overall of 7.7%. But because their stock markets are playing catch up, emerging market stock markets only account for 7% of world stock market value.

This is the opportunity.

Emerging market ETFs include iShares MSCI Emerging Markets (EEM) and Vanguard's slightly lower cost Vanguard Emerging Market (VWO). In the Vanguard ETF basket there are the following country allocations: South Korea, 15.7%, Taiwan, 12.4%, Brazil and China, 10.5%, Russia, 10%, South Africa, 8.6% and India and Mexico, 6.3%. There are also seven emerging market country iShares available if you prefer a rifle rather than shotgun approach. These ETFs cover markets in Brazil (EWZ), Malaysia (EWM), Mexico (EWW), South Africa (EZA), South Korea (EWY), Taiwan (EWT) and China (FXI).

By Carl Delfeld of the Chartell ETF Advisor

Finally, Some New Country ETFs From Barclays

I first became intrigued with exchange-traded funds when I saw the line up of country-specific ETFs on Barclays iShares menu. There are now 23 country ETFs including two that track the Japanese market.
My waiting for more country ETFs seems to have ended last week as an SEC filing listed the following ETFs in the pipeline: iShares MSCI BRIC Index Fund, iShares MSCI Chile Index Fund, iShares MSCI Israel Index Fund, iShares MSCI Thailand Index Fund and a iShares MSCI Turkey Index Fund. These are welcome but were certainly not at the top of my wish list. What about Ireland, Norway and Denmark?

Thailand is interesting as it has been the best market in Asia and is also still one of the world's cheapest. I have also gotten quite a bit of calls asking about turkey. Israel is a technology center that packs a punch way beyond its weight. Chile is a wonderful success story and the star of Latin America not to mention an excellent play on copper.

Many purists are scornful of the country ETFs since they tend to be dominated by a few big multinationals and also are increasingly less dependent of their domestic economy. I accept that they are a hybrid; part play on global growth and part play on the home economy. The emerging market country ETFs (There are seven of them) are more centered on their country's economy. Plus, studies have shown that where a company has its primary listing and the perception of its home economy does impact stock prices.

Regardless, I find it continually fascinating to buy a county's stock market with just a click of the mouse.

By Carl Delfeld of the Chartwell ETF Advisor

China ETF Government Risk

I am not sure that many investors in the China exchange-traded fund or ETF (FXI) realize that the 25 companies in the China ETF basket are all state owned and/or controlled. Some may like this since they believe that the Chinese government will not allow these "crown jewels" to fail. This weeks market turbulence should underline that global markets are more powerful than even a central government with more than $1 trillion in foreign exchange reserves.

Furthermore, more than 70% of the shares of China's 1,377 listed companies are substantially owned by the state. China has missed a great opportunity to privatize many of these companies but my unmistakable conclusion is that they are unwilling to do so and give up control - especially for the top companies they are grooming for global competition.

The Chinese adage of "crossing the river by feeling the stones" may be wise at times but in the case of privatization, a plunge into the river a decade ago would have been much better for the Chinese economy and people.

By Carl Delfeld of the Chartwell ETF Advisor

Is it Too Late for India ETF?

Global ETF investors have waited a long time for the India ETF (INP) which has been weakening over the past week.. But now that the India ETF is trading, (actually it is an exchange-traded note) is the India story and India ETF still compelling?

Mr. Vedant Mimani and Mr. Rahul Saraogi of India specialist Atyant Capital think that odds are that investors jumping in at this time into the leading companies that lead the SENSEX index (India’s Dow Jones) may be in for a rude awakening. They point out that the 50% plus gains in the SENSEX index during 2006 have brought the total capitalization of the index to 1.2 times India’s GDP. The gains are also centered on the very largest companies while 1,100 of the 6,000 or so companies that trade on the exchanges are actually at 52 week lows.

Furthermore, India’s government is making little progress in crucial areas such as market reforms, infrastructure, corruption and rural development.  Carl Delfeld, President of the Chartwell ETF Advisor agrees with much of this analysis and has recommended to members of the Chartwell Advisor not to invest in the new India ETF at he present time. In particular, he will have an article in the next issue of Forbes Asia which focuses on the problems of rural India and the need for much more progress on market returns for private investment in infrastructure. Furthermore, Chartwell uses a better proxy for the India market in its ETF model portfolios.

Global Diplomacy and ETFs

Exchange-traded funds or ETFs are not just about economics and business but global power politics as well. This is especially true for country ETFs like China (FXI), India (IFN) and Russia (in the works).

Tomorrow, China, Russia and Indian foreign ministers will hold a summit in India to discuss who knows what. This is their first trilateral meeting and follows Mr. Putin's sharp criticism of the United States earlier this week. On Thursday, Li Zhaoxing, China's foreign minister heads to Japan to meet with his counterpart Taro Aso. One topic will surely be issues related to the expected visit to Japan by China's premier Wen Jiabao in April 2007.

Meanwhile, tension between Taiwan and China is heightened by Taiwan (EWT) pulling the "China" label from several state-owned companies.

No Love For Russian ETF

Van Eck Global is planning to offer an exchange-traded fund (ETF) that will invest only in securities of Russian companies that trade on international exchanges. These funds represent a big bet on energy, because Russia's markets are dominated by giant oil and gas names, such as OAO Lukoil.

But because of Russia’s back peddling on market reforms, growing corruption, poor corporate governance and moves away from democracy, Carl Delfeld of the Chartwell ETF Advisor has no love for the upcoming ETF. He advises members to look at other global energy ETFs such as (IXC) as a safer and higher quality energy play

Is the India ETF Overheating?

By Carl Delfeld of the Chartwell ETF Advisor

India’s economy and the India closed-ended ETF (IIF) has been on a hot streak. Is the ETF’s sparkling performance sustainable?

An article in the current Economist points out that India’s real GDP grew by 9.2% in the year to last September. Over the past four years it has increased at an average annual pace of more than 8%, compared with around 6% in the 1980s and 1990s.

Prices and inflation are also moving upward. Wholesale-price inflation has risen to 6%, which is above the 5.5% upper limit set by the Reserve Bank of India (RBI). The article also highlights that industry capacity utilization is higher than at any time in the past decade and severe skill shortages have caused wages and salaries to rocket – and not just for software engineers. The RBI is also concerned about a credit boom with bank lending to firms and households has expanded by 30% over the past year. Lending on commercial property is up by 84% and home mortgages by 32%. Asset prices look out of control. India’s stockmarket also looks frothy after rising more than fourfold over the past four years. India’s stockmarket is one of the emerging world’s most expensive, with a price-earnings ratio of more than 20. House prices in many big cities have more than doubled over the past two years.

In short, investors should be careful jumping in at this point and use a stop loss to lock in gains and limit downside. Protect yourself from the inevitable market pullback.

Break The ETF BRIC

During the past year, investor interest in the so-called BRIC countries: Brazil, Russia India and China has skyrocketed with a commensurate rise in respective share prices.

Is it too late to jump on the bandwagon? What is the best way to invest in these countries and what allocations should be made to each country in the BRIC group?

Fund flows into BRIC countries have risen sharply during 2006 and these markets have bounced back nicely from the sharp June pullback. Interestingly, China has captured about half of all the net increases in investment from global equity managers. This BRIC mania has obscured three important basics about these markets.

The first is that these are without doubt less developed emerging markets with commensurate volatility and risk. If you got carried away in 2006, take some money off the table – now.

Second, your strategy for investing in these markets should be long term. The whole idea is that over time these faster growing markets will translate into above average returns but no doubt there will be lags and bumps along the way.

Third, it would be a mistake to view these four countries as just four cogs in a wheel. Each country has its own strengths and weaknesses and will probably not move together.

Russia for sure and Brazil to a lesser degree are essentially commodity plays. Russian share prices are highly dependent on energy prices and since all other indicators such as political freedom, manipulation of foreign investment, cronyism and market reforms are going the wrong way, I am highly skeptical of this market.

Brazil offers more hope but is also dependent on commodity prices since they account for 40% of all exports. President Lula’s re-election this year may lead to more aggressive market reforms or a pullback which would inevitably lead to the familiar boom and bust cycle.

China and India are the most promising BRIC options. Both markets have been red hot and China is riding a super cycle of investment which may very well extend through the 2008 Olympics. It is clearly in the midst of building a world-class infrastructure in urban areas but the familiar risks such as its state-dominated economy, lack of any democratic reforms, and tensions in rural areas where the majority of Chinese still struggle might derail the prized “stability” so touted by the Communist leadership. 

My view is that India over the long haul presents investors with the great bull market of the 21^st century. India however, also faces daunting challenges such as how to finance the modernization of its woeful infrastructure given its high debt levels and ambivalence towards foreign investment and privatization? Another key issue is timing. Large cap Indian companies have had a terrific run and seem quite expensive at about 20 times earnings. If earnings stay strong in 2007, the market could strengthen, but if not, expect a sharp pullback.

The best way to invest in these BRIC countries is probably through low-cost, flexible, transparent exchange-traded funds (ETFs) and their kin - closed-end funds. Claymore introduced the first BRIC ETF this fall (EEB) which tracks liquid U.S. exchange-listed ADRs and GDRs. It should however be avoided since its top ten holdings account for 57% of the ETF’s total exposure. In addition, 49% of its holdings are in Brazil, 31% in China, 14% in India and 6% for Russia.

You would be better off to make your own BRIC allocations based on your risk profile and investment objectives using country specific funds. One option is to use the China iShare (FXI), the Brazil iShare (EWZ) and the Morgan Stanley India Fund (IIF) as proxies for these markets. Barclay’s is planning an ETN that will follow an index of the largest companies on the National Stock Exchange of India but this ETF will be market cap weighted.

  

I will wait to see the company weightings but will probably still prefer (IFF) because of its nice balance with the inclusion of several well respected Indian subsidiaries of world class multinationals such as Siemens and ABB. You need to carefully watch the premium that a closed-ended fund trades relative to its net asset value.

Where would I be right now in terms of a BRIC allocation? About 30% for China, 20% for India, 15% for Brazil, zero for Russia and 35% in cash.

BRIC investors have done very well this year. Take some of your gains and get your financial advisor a nice Christmas present.

Carl Delfeld

Brazil ETF Not Just Commodity Play

In 2006, while investing in BRIC countries was the rage, China and India received most of the attention. The China ETF (FXI) was up 84% and India’s SENSEX index was up over 50%. Meanwhile almost lost in the shuffle, the Brazil ETF (EWZ) was up 45.4% - not bad, not bad at all.

With 187 million people and an area only slightly smaller than the United States, this leading South American economic power together with Chile and Colombia are changing attitudes toward the region as a whole. But the lingering question is whether Brazil’s economic recovery is sustainable or just another stage in the economic cycle. 

What is most interesting to me is that Brazil’s stock market’s performance during the past four years is not due to superior economic growth. It has had an annual average growth rate of only 2.6%, about half of world economic growth during the same period.

My view is that Brazil has been primarily a balance sheet story supported somewhat by the commodity boom. With Brazil’s President Lula being sworn in for a second term today, let’s review Brazil’s accomplishments and challenges.       

Inflation is muted and was only 3% during 2006. Brazil is almost energy independent and foreign exchange reserves are now almost $100 billion after paying off its nettlesome IMF debt. In 2006, it recorded a trade surplus of $46 billion and while interest rates are high, they are beginning to fall. 

What Chartwell ETF Advisor’s Carl Delfeld now wants to see is Brazil turn into more of a growth story. This will depend on the second term reform agenda of President Lula. He is in a strong position with a 70% plus popularity rating and a solid governing coalition. 

Here are some of the issues Brazil needs to tackle to build a sustainable platform for economic growth and a continuing bull market. The tax burden needs to come down from current 50% levels. Public spending needs to be cut but also re-directed to infrastructure projects. Corruption needs to be sharply curtailed and overregulation slashed, especially in labor markets.

Finally, Brazil needs to substantially improve its education standards if it hopes to compete head on with India and China. If Brazil even takes small incremental actions to address these issues, global investors will take note and the Brazil ETF (EWZ) will continue its upward trend.

If interest rates decline as well - it could be another impressive year for investors who don’t forget that BRIC begins with Brazil.