ETF sponsors can’t resist latest trend

Now that exchange-traded funds can come to market with relatively little fuss, providers are readying to launch emerging-markets ETFs in what industry observers call an ill-advised attempt to jump on the latest trend.

Now that exchange-traded funds can come to market with relatively little fuss, providers are readying to launch emerging-markets ETFs in what industry observers call an ill-advised attempt to jump on the latest trend.

Many of the emerging-markets ETFs in the pipeline are too narrowly focused on individual countries, and in some cases on industries within those countries, according to advisers and industry watchers.

For example, newcomer Global X Management Co. LLC recently filed a prospectus to introduce ETFs targeting six Chinese industries: consumer goods, financials, energy, industrials, materials and technology.

At Emerging Global Advisors LLC, seven infrastructure and mid-cap index funds focusing on Brazil, China and India are in registration.

“When a preponderance of new products comes out, it’s usually a sign that the party is over or is close to being over,” said Paul Schatz, president and chief investment officer of Heritage Capital LLC, which advises on about $130 million in assets.

The planned ETFs will join 33 existing emerging-markets ETFs — seven of which were launched this year — with total assets of about $30 billion as of Oct. 31, according to Morningstar Inc.

Given the success of emerging-markets funds, it is no surprise that ETF producers have the category in their sights.

The recent run-up is irresistible to an industry that has the ability to launch products on short notice, said Jim Lowell, editor of the monthly newsletter Forbes ETF Advisor.

“If [ETF providers] see significant assets flowing into an asset class, they can move very quickly to register to file, deliver and market funds,” said Mr. Lowell, who is also a partner and chief investment strategist at Adviser Investments, a firm with $1 billion under management. “It really is unlike the mutual fund industry of old, where the registration process was long and drawn out.”

For example, ETF sponsors flooded the market with commodities exchange-traded products when commodities prices started to rise.

Today, there are more than 50 such products, some of which face an uncertain future because of Commodity Futures Trading Commission concerns over excessive speculation in futures markets.

Those bringing out emerging-markets ETFs, however, deny that they are trying to time the market.

“For us, it’s a continuation of our strategy; emerging-markets ETFs are very much what our firm is about,” said Bruno del Ama, chief executive at Global X Management, who thinks that it is filling an investor need, not being trendy.

“Obviously, emerging markets have performed very well over the last few months,” he said, noting that U.S. investors typically underweight the category. “Investors are starting to rectify that, and ETFs are a great tool to facilitate that process.”

Emerging-markets ETFs, however, are far from perfect.

“Whenever you get a little more niche, you get a little more portfolio concentration,” said Scott Burns, director of ETF analysis at Morningstar Inc.

For example, the HealthShares ETFs, which were advised by XShares Advisors LLC, disappeared in large part because they sliced up the health care market a little too finely to be of much use to the average investor, he said.

Unfortunately, some of the newest emerging-markets ETFs, and those that are planned, also may be too narrow.

For example, the iShares MSCI All Peru Capped Index Fund (EPU) launched in June by Barclays Global Investors, is highly concentrated in commodities-related companies in that country.

“With the fastest-growing economy in Latin America and one of the lowest inflation rates in the region, Peru’s essentially untapped market offers diversification benefits and poses an attractive opportunity to investors,” Daniel Gamba, chief executive of Latin America for iShares, said in a statement when the ETF was launched.

But the ETF is overweight in materials producers. Buenaventura Mining Company Inc. (BVN), a gold and silver mining company, alone makes up more than 18% of the portfolio, according to Morningstar.

Another problem with emerging-markets ETFs — especially those that target individual countries and industries — is liquidity, said Paul Simon, chief investment officer at Tactical Allocation Group LLC, which has about $1 billion under advisement.

A lack of trading volume could result in a big spread between the bid price and the ask price, a situation that can be an issue even with broad-market ETFs, he said.

For example, Mr. Simon favors the iShares MSCI Emerging Markets Index (EEM) over the comparable Vanguard Emerging Markets Stock ETF (VWO), from The Vanguard Group Inc., because the iShares ETF generally has greater trading volume. Still, in an example of the trade-off investors face when evaluating ETFs, he is re-evaluating his use of the iShares ETF because its Vanguard counterpart is cheaper and has been taking greater market share.

At this time, there is no better way to get access to emerging markets than through an ETF, said Melvin Herman, chief executive of XTF Global Asset Management LLC, a firm specializing in ETF research and portfolio development.

Emerging-markets ETFs may be highly concentrated, but they still offer some diversification, he said.

“For the investor, it’s certainly better then picking one specific company in an emerging market that they have no knowledge about,” Mr. Herman said.

The key is not to rush into any ETF, Mr. Simon said. Investors need to look under the hood to better understand the risks involved, he said.

E-mail David Hoffman at [email protected].