Actionable ETF Investment Ideas: April 2011
There was no shortage of activity in global equity markets in March, as the crisis in the Middle East intensified and the fallout from a natural disaster in Japan was felt around the globe. The month was a touch stretch for some portfolio, as the spike in uncertainty pummeled risky asset classes, including many commodities.
We’re certainly not full blown bulls in the current environment, but believe that the events of the last several months have created some attractive opportunities, ranging from international debt markets to overlooked corners of the U.S. equity space:
Asia Local Debt Fund (ALD)
Innovation in the bond ETF space was one of the major themes of the last month, with a handful of products debuting that offer ways for investors to diversify geographic exposure beyond U.S. borders. The Asia Local Debt Fund (ALD came flying out of the gates, debuting with more than $100 million in assets. And for good reason; this product offers a way to enhance expected yield, diversify risk, and establish a hedge against the U.S. dollar, all in one.
ALD’s focus in broad in nature; this product offers exposure to a dozen different countries, including both developed and emerging markets. One thing these debt issuers have in common is an attractive yield profile; interest rates are considerably higher in Asia than they are in the U.S., meaning that the current return expected of ALD is materially higher than comparable products comprised of U.S. debt. The embedded income yield for this product is about 3.5%, as is the yield to maturity.
There is a feeling among some investors that debt of emerging markets issuers is inherently risky. While that may have been the case historically, the last few years have turned more than one historical relationship on their head. Of the 12 constituent countries in the fund, seven are in the top twenty in terms of total forex reserves, suggesting that many of the countries will be able to repay debt if a crisis ensures, further highlighting the risk/reward profile of these economies.
ALD won’t shoot the lights out, and doesn’t have quite the return potential of many equity ETFs. But we truly believe this product offers the Holy Grail of fixed income investing: higher yields and lower risk. Make room in your portfolio for some ALD, and take advantage of this new product to diversify fixed income exposure a bit.
First Trust ISE Global Engineering And Construction Index Fund (FLM)
As the situation continues to slowly improve in Japan, many in the country are likely to focus on the monumental task of rebuilding the nation. By some estimates, rebuilding the damaged areas could cost the country as much as $300 billion and some are even calling for a tax hike in order to pay for the reconstruction efforts. As tragic as the situation has been, it could create a windfall for a number of firms engaged in engineering and construction operations as these giants look to be called in immediately in order to apply their expertise and get Japan back to pre-quake levels as soon as possible. With wide support for the tax increase to pay for the efforts, as well as plans to scrap other tax cuts to help generate extra revenue, it seems as though the highly-indebted nation will be able to find a way to pay for the damage without greatly adding to its ultra-high debt burden. Due to this, I look for FLM to rise modestly in April as the Japanese government discusses more concrete plans for rebuilding and even doles out some initial projects to contractors across the stricken region. This could help give a large boost to many of the firms in FLM which have struggled in the past thanks to a lack of infrastructure demand but could return to prominence thanks to the Japanese quake and the incredible need for infrastructure improvements in the region, despite the country’s heavy debt load. In fact, FLM’s top country holding goes to Japan; the nation’s securities make up slightly over 15% of the fund’s total assets, ensuring that FLM has plenty of local exposure that can help to lead the fund higher in April trading.
Short Uranium ETF (URA)
Since tragedy struck Japan, nuclear power has been under the microscope as efforts to minimize radiation leaks are still ongoing. The massive tsunamis that struck various parts of the country did major damage to several of Japans nuclear power plants, leaving several in a dangerous state with workers desperately trying to control the situation. With the possibility of a major radiation leak, major catastrophes such as Cherobyl and Three Mile Island come to mind as what can happen as a consequence of nuclear power. With the possible devastation that a radiation leak could cause, much of the world is beginning to question the use of nuclear power as a viable source for energy. Germany, the world’s fourth largest economy, even announced plans to abandon nuclear power altogether, and there is speculation that others could follow suit, causing a potential meltdown for nuclear power worldwide.
One of the key elements in a nuclear power plant is uranium; as uranium rods are used to produce steam, turning a turbines, which ultimately generates power for any given nuclear plant. Being such a vital part of such a now controversial energy source, uranium has also been under the microscope, as a drop in nuclear energy would consequentially mean a significant decrease in uranium use. The Uranium ETF (URA) holds a number of companies that are active in the Uranium mining industry, giving investors equity exposure to a commodity. In the coming four weeks, the unfortunate situation in Japan may translate into lower prices for this ETF, making it a strong option to short. If the the radiation leaks persist, or any major movement against nuclear energy arises, which seems likely, this fund will likely be the big loser. The debate for this investment is not whether or not you think nuclear energy is a good/bad energy source, it is simply making a play on the continuing issues in Japan as well as major economies pledging to abandon nuclear power in the near future.
Short CurrencyShares Euro Trust (FXE)
The Euro Zone is still a mess and yet the euro has been climbing higher and higher in the currency markets, especially versus the dollar. Inflation is currently at 2.4% in the region, while unemployment remains at a high 9.9%. To top it all off, Ireland, Greece, and Portugal are still not out of the woods by any means. Despite the worsening credit quality of its constituents and ongoing concerns of inflation, the euro has managed to appreciate against all odds.
The European Central Bank is slated to announce their interest rate decision on Thursday (4/7/2011) for the month of April. Speculators are preemptively betting on an interest rate hike following commentary by ECB President Jean Claude Trichet last week, during which he emphasized his intents to control inflation. The bank has kept interest rates at 1% since May of 2009, and analysts are expecting the first rate hike to come in this month. While the euro has many fundamental weaknesses, expectations of a rate hike have certainly proven to be a positive catalysts going forward. The ECB forecasts inflation to be below 2% next year, however, Trichet is still worried and he has expressed his concerns about inflation going forward. If monetary policy is tightened sooner than expected, then prospects for growth will likewise be revised, given the weak economic recovery of the euro zone thus far.
This recommendation is based on the simple fact that traders have already priced in a rate hike. If the ECB keeps rates constant, or fails to provide any bullish commentary going forward, then the euro will likely fall lower versus the greenback in April, sending FXE under $140 a share. Possible disruptions include an unexpected hike from the Bank of England, which announces rates just before the ECB on Thursday. If the ECB does stick to its guns, and raises rates, then expect FXE to trade higher in April, most likely hitting $145 a share before the month ends.
Last Month’s Actionable ETF Plays
|Ticker||ETF||Monthly Return||Our Take|
|SGG||iPath Sugar ETN||-8.2%||March was a brutal month for sugar futures, as inflationary pressures eased, supply concerns proved to be unfounded, and demand in emerging markets dropped off a bit. Sugar futures markets remain in backwardation, so we continue to like this ETN as an option for more risk tolerant investors seeking commodity exposure.|
|FXC/FXY||Long Rydex CurrencyShares Canadian Dollar Trust/ Short Rydex CurrencyShares Japanese Yen Trust||+1.8%||For the better part of March, this choice appeared to be a terrible pick. The yen was soaring after the earthquake as numerous Japanese investors were repatriating their assets back to their home currency in light of the disaster. Meanwhile, the loonie was pretty much flat during the middle part of the month despite surging oil prices and high values for many of the country’s agricultural commodities. Nevertheless, a late-month surge pushed this pick to positive territory and helped erase all of the losses from the middle of the month.|
|TAN||Guggenheim Solar ETF||8.9%||March started off rough for solar energy, as political unrest in Libya contributed to markets across the board sinking. But after the unfortunate tragedy in Japan, many questioned the viability of nuclear power as an alternative energy, sending other forms, like solar, through the roof to finish out the month strong.|
|ENZL||iShares New Zealand ETF||
|This was an attractive pick going into March, considering that the fund saw an exaggerated sell-off following the earthquake in Christchurch. Going long ENZL played out fairly well, even after the broad sell-off following the tragic earthquake in Japan. New Zealand equities will likely continue higher, given the extensive recovery efforts in Japan coupled with a weak U.S. dollar, which has been boosting Australian stocks as well.|
|ETFdb 60 Index||+0.6%||This broad measure of asset classes available through ETFs climbed higher in March, as strong performances from commodities and many equities offset the damage done by the earthquake in Japan.|