The ETF industry has expanded by leaps and bounds in recent years, with new issuers entering the arena and countless new product launches that offer investors the ability to gain exposure to various geographic regions and investment styles. The first ETFs were essentially “plain vanilla” products that mirrored widely-followed equity benchmarks. Today, the vast majority of ETF assets is still invested in these more traditional funds, but numerous more exotic products are gaining in popularity. Enhanced index ETFs, actively-managed ETFs, long/short ETFs, and leveraged ETFs are just a few of the innovations that have been embraced by investors.
Some contend that the ETF industry is nearing a saturation point, noting that dozens of funds have struggled to attract a sufficient asset base and could be in danger of closing. We think quite the opposite. Although investor demand is difficult to predict, here’s a look at ten ETF strategies we’d like to see hit the market (sign up for our Free ETF Newsletter to see if any of these ETFs ever make it to market):
1. Targeted Corporate Bond ETFs
Despite the importance of the fixed income asset class in a well-diversified, long-term portfolio, the fixed income ETF options are relatively limited, particularly for investors looking to gain exposure beyond Treasuries. According to our Free ETF Screener, there are only about 75 fixed income ETFs available, compared to more than 600 equity funds. And most of the existing ETF products have significant allocations to Treasuries and U.S. agency securities, which makes them less appealing for investors interested in following a Ben Graham-esque investment strategy.
LQD offers diversified exposure to the corporate bond market, but it’s essentially the only product covering this area. More targeted corporate bond ETFs (by industry, duration, credit quality, etc.) would likely be a huge hit with investors.
2. Poland ETF
Poland is the world’s 18th largest economy by GDP, but there is no ETF devoted exclusively to the Polish equity markets. ETFs focusing on Thailand (#35 on the list of largest economies), Israel (#42), and Peru (#55) are all available to U.S. investors, but exposure to the Warsaw Stock Exchange is hard to come by.
Poland is a shining example of a country that successfully transitioned from a centrally-planned economy to a capitalist market-based economy, thanks in large part to aggressive policies implemented since the fall of communism. Poland has a large agricultural sector, and if the nation becomes more closely aligned with the rest of Europe (Poland was scheduled to enter the euro zone in 2012, but that date was recently canceled), it could become the primary food supplier to the EU.
Poland faces many obstacles, including high unemployment and net outflows of workers, but offers some intriguing investment opportunities as well.
3. Alternative Inflation-Protected ETF
As worries about the intermediate to long-term impacts of the massive stimulus plans proliferate, inflation-protected bond ETFs have become an increasingly important risk reduction tool in many investor portfolios. But there are some drawbacks of investments in TIPS. Since principal amounts are based on CPI as reported by the government, if these figures are manipulated or under-reported (as many believe they are), returns offered by these products may be subject to “inflation erosion” after all.
We’d love to see an inflation-protected ETF (or, more likely, an ETN) that independently measures and reports price increases and decreases (using a transparent methodology). Such a product should put the minds of conspiracy-theorists at ease, and appeal to “black swan” investors.
4. Egypt ETF
The geographic reach of exchange-traded products has expanded significantly in recent years, but coverage of Africa remains rather thin. While there are ETFs offering diversified exposure to Africa (Van Eck’s AFK), country-specific exposure is limited to South Africa (through iShares’ EZA). As investors regain their appetite for risk, new emerging and frontier market investment opportunities may garner some interest [see more holdings of AFK here].
Egypt’s economy is led by the service sector, including tourism, trade, and banking. Given its proximity to the Suez Canal, shipping services are also a major component of the economy. Investments in Egypt are obviously risky – trade deficits, high inflation, and heavy government regulations are just a few barriers to over come – but the country offers a unique opportunity for investors looking to gain exposure to Africa.
This ETF may become a reality at some point in the near future, as Global X filed for approval [PDF] of the Global X FTSE Egypt 30 ETF with the SEC late last year.
5. Bill Gross Actively-Managed Bond ETF
Pimco recently completed the successful launches of two fixed income ETFs, and has already established itself as a major player in the space. The Newport Beach, California-based firm is the world’s largest bond fund manager thanks in part to the stellar track record of co-founder Bill Gross.
Actively-managed equity ETFs have already hit the market, and many anticipate that Pimco will soon jump into the actively-managed bond ETF game (PowerShares has already pioneered this space, launching the first actively-managed bond ETF, PLK, in April 2008). If Pimco does launch a product that combines Gross’ proven investment strategies with the benefits of the exchange-traded structure, it will surely be a hit among investors.
6. Ultra-Risky, Ultra-Aggressive ETF
ETFs that diversify across multiple asset classes are nothing new. iShares offers an aggressive allocation ETF (in addition to conservative and moderate allocation funds), but AOA is heavy in large and mid cap domestic equities, which fall somewhere in the middle of the investment universe risk continuum [see more information on AOA's fact sheet].
It’s time for an ETF that takes aggressive asset allocation to the extreme. So how about an ultra-aggressive allocation ETF that maintains equity exposure through small-caps and emerging markets and fixed income exposure from emerging markets bond funds? I imagine an “ETF of ETFs” that looks something like this:
|EEM||iShares MSCI Emerging Markets Index Fund||60%|
|DGS||WisdomTree Emerging Market SmallCap Fund||20%|
|EMB||iShares JP Morgam Emerging Markets Bond Index Fund||10%|
|RWX||SPDR DJ Wilshire International Real Estate ETF||10%|
In recent years, we’ve seen the introduction of frontier markets ETFs, 130/30 ETFs, hedge fund ETFs, and other unique high-risk funds. These types of funds could also be used to round out the ultra-aggressive allocation ETF and provide opportunities for enhanced returns (see our Free Guide to ETFs for Very High Net Worth Investors for more ideas).
7. Non-USD Currency ETFs
Currency ETFs have become a popular way for investors to gain quick and easy exposure to exchange rate movements, but the products available are generally limited to dollar-based ratios. Investors looking to make a play on JPY/EUR or GBP/AUS exchange rates can’t do so through ETFs (at least not through a single ETF).
While ETFs gained notoriety as powerful tools for constructing long-term buy-and-hold portfolios, the popularity of leveraged ETFs (and existing currency ETFs) indicates that they have been embraced by short-term traders as well. These ETFs would primarily be designed for short-term speculators, but would also be useful in certain longer-term hedging situations.
8. Automotive ETF
The global automotive industry has been hammered by the recent economic downturn, and the U.S. market will likely never be the same again. But the fact that the prospects for the industry are less than bright doesn’t necessarily mean the stocks won’t be popular. During the recent “crisis” financial sector ETFs were frequently among the most heavily-traded, as sharp rises and declines presented opportunities for big short term profits.
A global automotive ETF comprised of both manufacturers and their suppliers could be a big hit. This type of ETF likely wouldn’t appeal to the buy-and-holder, but could become a popular fund among investors with a more immediate time horizon. The release of monthly sales figures would ensure consistent days of heavy trading, and the volatility of the underlying stocks would be irresistible for speculators.
9. Long Term Leveraged ETFs
Leveraged ETFs have been a topic of great controversy this year, with much of the debate surrounding the performance of these funds when held for multiple trading sessions. Because leveraged ETFs reset daily, returns over extended periods of time (anything longer than a day) depend on both the change in the underlying benchmark and the market’s direction. In volatile, seesawing markets, bull leveraged ETFs can post losses even if the benchmark gains.
But there are ways to stabilize leveraged ETF over the longer term. Devising and implementing a rebalancing strategy is actually rather simple, and can allow investors to generate amplified returns (or sustain amplified losses, depending on your ability to predict market movements). For a closer look at rebalancing strategies, see our Free Guide to Leveraged ETFs.
The idea here is to take a rebalancing plan within the ETF structure, essentially creating a fund that can deliver a target multiple of an underlying index over an extended period of time with minimal tracking error. Of course, the logistical difficulties of implementing this type of strategy in an efficient manner would likely be staggering, but if any issuer could pull it off, it would likely be a very popular innovation.
10. Ireland ETF
In June 2008, Northern Trust launched the NETS ISEQ 20 Index Fund (IQE), which tracked the largest stocks traded on the Irish Stock Exchange. But Northern Trust’s stint in the ETF industry was a short one, and when the company pulled out in February of this year, U.S. investors were left without an ETF option for investing in the “Celtic Tiger.”
Ireland has witnessed a dramatic economic resurgence in recent decades, as educational reforms and low corporate tax rates made the Emerald Isle a popular destination for foreign investments. Recently, however, Ireland has fallen on hard times, with first quarter GDP declining by 8.4% from the same period a year earlier (compared to 4.9% for the broader euro zone).
Ireland’s economy is dominated by tech companies and financial firms, making it a unique investment opportunity compared to the rest of Western Europe. Ireland ETFs have been considered before, as both PowerShares and State Street have filed for regulatory approval of similar funds.
Have another idea for an ETF you’d like to see? Let us know in the comments below!
Disclosure: No positions at time of writing.