Never Judge An ETF By Its Cover

by on May 31, 2011

As hundreds of billions of dollars have flowed into exchange-traded products in recent years, international equity ETFs have been a particularly popular destination. As investors have shed their “home country bias” and recognized the importance of meaningful international equity allocations, the low costs and instant diversification offered by the exchange-traded structure have understandably served as major selling points. And given the often significant volatility in some international markets, the ability to execute trades intraday also stands out as an important quality for investors [see Five Free ETF Tools].

There are dozens of country-specific ETFs, offering pure play exposure to markets that are home to some of the world’s biggest and most important economies (23 China ETFs according to the ETF screener) down to the relatively small and lesser-known (such as Egypt and Vietnam). In addition to the numerous funds focusing on specific countries, there are also several products designed to give exposure to a specific region–anywhere from a pair of countries to a dozen or so economies. From ASEAN and the BRIC ETFs to Latin America and Pacific Rim, investors looking to cast a slightly wider net and scoop up access to a handful of similar economies, regional ETFs can be extremely useful tools for putting on a tactical tilt towards a select grouping of international economies.

While most regional ETFs balance exposure across component countries, the composition of others demonstrates why it always pays to look under the hood of a prospective ETF investment. Below, we highlight a few ETF that may appear at first glance to offer exposure to a basket of economies, but that in reality are essentially country-specific options [for more ETF insights, sign up for our free ETF newsletter]:

  • SPDR S&P Middle East & Africa ETF (GAF): This fund seemingly offers access to a unique mix of international economies; those seeking exposure to the hard-to-reach emerging and frontier markets of the Middle East and Africa may be drawn to GAF as a way to achieve one stop exposure. But a look at the fund holdings reveals that about 90% of the components are South African stocks; Egypt makes up about 6% of the fund and Morocco accounts for 5% or so. Missing completely are the economies that make up GULF (including Qatar, UAE, and Kuwait) or those the comprise the Market Vectors Africa ETF (AFK has a big weighting in Nigeria).
  • WisdomTree Pacific ex-Japan Equity Income Fund (DNH): This ETF may be appealing to investors looking to access economies of the Pacific while steering clear of Japan, which has struggled for several decades now to post sustainable and material GDP growth. Some may view other Pacific economies, such as Australia, New Zealand, China, Hong Kong, and Singapore. However, DNH is essentially an Australia ETF; this developed economy accounts for about 92% of assets; New Zealand accounts for only about 4% and Singapore takes up another 3% or so. It should be noted that WisdomTree currently has plans to overhaul both the name and focus of DNH; in July, this fund will become the WisdomTree Australia Dividend Fund, becoming a pure play Australian ETF focusing on dividend paying Aussie stocks. For those seeking more balanced Pacific ex-Japan exposure, DND may be worth a closer look [see the Free ETF Country Exposure Tool].
  • MSCI Emerging Markets Eastern Europe Index Fund (ESR): The economies of Eastern Europe have become increasingly interesting in recent years, distinguishing themselves from their euro zone counterparts by generally sound fiscal footing and ability to deliver meaningful GDP growth as the rest of the region struggled simply to avoid contraction. Countries such as Poland, Hungary, the Ukraine, and Czech Republic generally do not receive big weightings in broad emerging markets ETFs such as VWO and EEM, so a regional product may seem like an efficient way to increase the presence within a portfolio. ESR, however, is dominated by Russian energy stocks; the “R” of the BRIC bloc accounts for about three quarters of fund assets, and the energy sector makes up about 40% of the portfolio. Russian natural gas giant Gazprom alone represents about 22% of assets, another illustration of the concentration issues present in this fund [Who Else Wants A Real Eastern Europe ETF?].

The three ETFs highlighted above are by no means funds to be avoided; each offers cost-efficient international exposure that is relatively unique. But the names and compositions of these products should illustrate the importance of looking beyond the title of any product, and examining the holdings to get a true grasp of the risk/return profile offered [use the Country Exposure Tool to find which ETFs offer exposure to certain countries].

[For more ETF analysis sign up for our free ETF newsletter.]

Disclosure: No positions at time of writing.