The Big Picture for the Week of September 5, 2010

The Wall Street Journal posted an article about ETFs which made a point that I have been making here and at the Street.com for years which is about the need to look under the hood of any ETFs you study or buy to see what the largest holdings are and depending on the weight of those largest holdings learn a little about these stocks.

For example the article notes that that the largest holding in the GlobalX Colombia ETF (GXG) is Ecopetrol (EC) at 22% of the fund. It is tough to say what weighting should be studied as that can be an eye of the beholder thing. I think most people could agree that a stock weighing in at 20% or more should be studied but what about a stock at 15% or 10%? My own sense of curiosity is to want to learn about the economy first, sort of what makes it tick, then look at largest few stocks at a minimum and then scan down all the holdings to see whats there (yesterday I took a quick gander at a Taiwanese bicycle manufacturer).

One of the bigger macros here, although not stated expressly, should be the desire to not get blindsided by the holdings in your ETF. The iShares Ireland ETF (EIRL) is a great example. The fund came out after all the bank stocks imploded yet that sector still comprises 14% of the fund, again this is after the sector imploded. If I were going to buy that fund I would want to keep close tabs on CRH which comprises 20% of the fund and keep in touch with the headlines for the banks, there are still plenty if you read the FT.

I don't view the concentration as a drawback per se. In trying figure the best way into something, usually a stock or an ETF, the overall composition in terms of prominent stocks and sector weighting either is the better choice or it isn't. If it is better, great, buy the ETF and if not then buy a stock.

Not stressed enough in the article is that in addition to single stock concentration, sector make up is crucial as well. Many country funds are very heavy in the financial sector. iShares Singapore is about 50% financials, Market Vectors Egypt (EGPT) is about 47% financials and the iShares FTSE Xinhua China 25 ETF is also 47% financials. A portfolio of country funds, depending on the countries chosen, could have a gross overweight in financials. Not that the 15% I target for the sector has to be right but 30-40% in the sector seems wildly excessive to me.

A point I've made a few times is that ETFs offer ease of access but this does not mean that people should assume they offer short cuts; they don't.