ETFs for Hard to Reach Places

by on September 2, 2014

Since the SPDR S&P 500 ETF (SPY) made its debut in 1993, the ETF industry has slowly but surely flourished over the last two decades, quickly becoming a valuable tool for investors and traders alike. From plain vanilla funds to hyper-targeted ETFs, the wide array of options has made it possible for investors to tap into nearly every corner of the investable universe, including some previously hard to reach places. In this piece, we highlight how the ETF industry has made it possible for investors to access securities that would be hard to invest in otherwise [see 10 Questions About ETFs You've Been Too Afraid To Ask].

Futures

For many individual investors, making an investment in futures used to involve the need to open up a costly (and complex) futures trading account. Therefore, tapping into asset classes such as commodities was not exactly in the realm of possibility for average investors.

Given the complexities of futures trading, the introduction of exchange-traded products offering exposure to this asset class has made it easier, cheaper, and more efficient for investors to tap into futures. In recent years, however, a new breed of innovative ETPs has emerged, which try to mitigate the risks associated with futures trading (such as contango). 

Currently, investors can tap into multiple futures contracts, such as commodities, currencies, or even managed futures strategies

Volatility

The Chicago Board Options Exchange (CBOE) Volatility Index (VIX) began trading in 1993, and is designed to measure the 30-day implied volatility of the S&P 500. The index is often referred to as the “Fear Index” since it almost always moves in the opposite direction of markets; so when SPY is up, VXX is usually down and vice versa, making it a popular hedging tool for active traders.

Prior to ETFs, however, investors needed a futures account to invest in volatility. In 2009, Barclays iPath became the first issuer to offer investors easy access to the S&P 500 VIX Index, with its debut of the S&P 500 VIX Short-Term Futures ETN (VXX) and the S&P 500 VIX Mid-Term Futures ETN (VXZ).

Now, there are more than 15 exchange traded products that offer exposure to volatility futures, including leveraged and inverse options.The five most popular volatility funds are:

  • S&P 500 VIX Short Term Futures ETN (VXX)
  • VelocityShares Daily Inverse VIX Short Term ETN (XIV)
  • Ultra VIX Short-Term Futures ETF (UVXY)
  • Short VIX Short-Term Futures ETF  (SVXY)
  • Daily 2x VIX Short Term ETN (TVIX)

Currency and Currency Hedging

As is the case with volatility, investors need a separate forex trading account to make a play on currencies prior to ETFs. Now, however, there are several exchange traded products that easily offer access to this asset class.

In general, there are two main types of currency ETF products: those that reflect a specific currency versus the USD, and those that reflect a basket of currencies against the USD. For example, a currency-specific ETF, such as the CurrencyShares Euro Trust (FXE) tracks the euro/USD forex pair. The Dreyfus Emerging Currency Fund (CEW) on the other hand, is a currency basket ETF, investing in multiple currencies relative to the USD [see Unconventional Uses for ETFs].

Typically, these tools are used to hedge against or profit from fluctuations of a particular currency (or basket of currencies) relative to the U.S. dollar. In addition to utilizing currency ETFs to make a play, investors can also use currency-hedged ETFs to tap into foreign markets, while at the same time mitigating currency risk. Like currency ETFs, currency-hedged ETFs can either be hedged against fluctuations between a single currency versus the USD or a basket of currencies against the USD. 

Frontier Markets

In recent years, a handful of ETF issuers began offering investors access to the world’s least developed economies, those that fall short of even “emerging” status [see Everything You Need to Know About Frontier ETFs].

Categorized as frontier markets, securities from these economies are typically small or micro cap companies with relatively low trading volumes. Traditionally, equities from several of these frontier markets were considered hard-to-reach, but thanks to the rapid development of the ETF industry, investors now have three options:

  • MSCI Frontier 100 Index Fund (FM): This Fidelity fund is the largest and most popular option for those looking to add frontier market exposure. FM has over 130 stocks in its portfolio, of which more than half are companies from the Middle East. 
  • Next Emerging & Frontier ETF (EMFM): This Global X fund has over 200 individuals securities in its portfolio, including companies from Malaysia, Mexico, South Africa, Indonesia, and Thailand.
  • Frontier Market ETF (FRN): This Guggenheim offering invests in only about 35 individual stocks, the majority of which are large and mid cap companies. Latin American equities are allocated over three-fourths of the fund’s total assets. 

Emerging Market Bonds & Equities

Like frontier markets, emerging market equities and fixed income securities used to be relatively difficult and expensive for average investors to tap into. Now however, investors can purchase an entire portfolio of emerging market equities with an expense ratio of only 0.14%, or an emerging market bond fund, which charges 0.35%. 

With ETFs, investors have numerous options to play emerging markets. From hyper-targeted single-country ETFs to plain vanilla funds to even style, sector-specific, and quant-based options, finding an emerging market ETF option that falls in line with a particular risk/return profile and objective is fairly easy and inexpensive to do. 

For those looking for broad exposure, Vanguard’s FTSE Emerging Markets ETF (VWO) and  iShares’ JPMorgan USD Emerging Markets Bond Fund (EMB) are by far the most popular options. The most heavily-traded equity option, however, is iShares’ MSCI Emerging Markets Index Fund (EEM), which has an average daily trading volume of over 40,000,000.

China A-Shares

Historically, the Chinese government on direct investments in the Chinese equities known as China A-shares, preventing foreign individuals and organizations from buying these securities in an effort to restrict the movement of capital into and out of the country. In recent years, however, these restrictions have started to ease.

Now, institutional investors can apply for the Qualified Foreign Institutional Investor (QFII) program, which allows approved foreign institutional investors to access the A-Share market. Getting approved for this status, however, is rather difficult; and even after a firm is approved, it faces strict restrictions on investing activity.

In the ETF industry, Deutsche Asset & Wealth Management was the first issuer to launch a U.S. ETF that invests directly in China A-shares with its debut of the db X-trackers Harvest CSI 300 China A-Shares Fund (ASHR)

Currently, there are only a handful of other ETFs that offer access to China A-Shares:

  • db X-trackers Harvest CSI 500 China-A Shares Small Cap Fund (ASHS)
  • China A-Share Portfolio (CHNA)
  • Bosera MSCI China A ETF (KBA)

The Bottom Line 

While average investors can certainly tap into these asset classes the traditional way, the evolution of the ETF industry has made it significantly easier and more cost effective to invest in these securities. Furthermore, investors can benefit from the other advantages these vehicles offer, such as intra-day tradability, transparency, and diversification.