The Big Picture for the Week of May 15, 2011

Following up on yesterday's mid-morning post, the ETF industry has kicked things up a notch in the last few days in a way that I believe is a net positive in terms of some new funds and filings.

As mentioned yesterday Van Eck came out with the Market Vectors LatAm Bond ETF (BONO) which offers a new narrow exposure in the ETP space. Next month the WisdomTree New Zealand Dollar ETF (BNZ) will become the WisdomTree Australian and New Zealand Debt ETF. I've been buying Aussie sovereign debt for clients for several years now. The conversion of BNZ democratizes this trade with a purer exposure than the Aberdeen Asia Pacific Fund (FAX) which owns mostly antipodean debt but the amount can vary. Some clients own FAX.

Next week's article for theStreet.com will be about BONO so without frontrunning it I will say that a combo of BONO and the new BNZ, properly sized, offers the chance for a very precise allocation that avoids a lot of shaky parts of the world. BONO is heavy in Brazil and Mexico. Each of those countries have their share of risks so anyone interested needs to do a little work there and come to their own conclusion but a foreign fixed income allocation that avoids Japan, the euro and the UK is worth exploring.

Also as mentioned yesterday Newton, MA (my hometown) based Direxion filed for a bunch of India ETFs including sector funds for financials, consumers, energy and utilities, industrials, infrastructure, materials and a tech and telecom fund. Also included in the filing is a fixed income fund. Of least interest to me would be the financial fund and there are several tech stocks that are have been easily accessible for a while. The materials fund might be 50% in Sterlite Industries (SLT) --slight hyperbole--and the rest in cement companies. Seriously there are a lot of cement companies in India. The energy and utility fund could be heavy in hydroelectric companies and the consumer fund would have a shot of capturing the ascending middle class--this is happening much slower than in China.

In general I think country-sector funds are preferable to broad country funds. If you have done some top down study on a country, it stands to reason that there could be some part of the country that you think is better to avoid. To bring up an example I've used before, Sweden is a country I want to own for clients, we've owned it for years with Volvo. The iShares Sweden ETF (EWD) has always had Ericsson as the largest holding. It is currently around 11% of the fund but it used to be more like 20%. There are several sectors in Sweden that I think could work out but I want no part of Ericsson so I've never seriously considered the fund. If there were a Sweden Financial Sector ETF I would be interested in that as I think the sector is healthy but the individual stocks are pretty thin.

If there is something to avoid in a country but has very little weighting then the broad country fund would be less of an obstacle; it is unlikely that the 3% allocated to utilities in SPY, if you hated that sector for some reason, could bring the whole thing toppling down.

Anyone that has been reading this site for a while knows I am a believer in building portfolios with narrower exposures, either individual issues or funds. Another aspect of portfolio construction is figuring out what to avoid. The new BNZ is a perfect example for someone who is favorably disposed to Aussie debt but who cannot access individual debt issues. Detractors will say that these funds are risky (although usually they mean volatile) but the riskiness of most products depends on how it is used. In thinking about permanent impairment of capital (a James Montier saying) a 3-4% allocation to something that is extremely volatile will not have a financial-plan-ruining outcome. The volatile thing may or may not work out as hoped for but proper sizing means it is not ruinous. However 50% in something that is extremely un-volatile can have a ruinous effect in some sort of worst case scenario for the product.

Anyone agreeing with this line of thinking will no doubt used narrow based products but anyone who cannot see this most certainly should avoid them.