I wear a lot of hats here at Weiss Research. I co-edit the Safe Money Report with Martin. I run a pair of our trading services focused on interest rates and long-term options. I work on special reports. And of course, I write a weekly column for Money and Markets.
One of my favorite jobs, though, is digging up new investment opportunities. I try to stay abreast of all the products hitting the market, and then separate the wheat from the chaff so our subscribers get nothing but the best possible picks.
These days, the most amazing new investment products I’m seeing are a host of exotic exchange-traded funds (ETFs). These aren’t your “father’s ETFs†– like the Standard & Poor’s Depository Receipts (SPY), which have been trading since 1993.
No, I’m talking about much newer … and hotter … ETFs that allow you to play a range of markets in ways that were never possible before.
These Exotic ETFs Are
Spreading Like Wildfire
My colleague Sean Brodrick makes a great case for using ETFs in “A Better Portfolio in 20 Minutes.†And as Sean points out, exchange-traded funds are becoming wildly popular with investors.
Heck, Morgan Stanley says the amount of money in global ETF funds should hit about $2 trillion within five years. That’s quadruple the current amount. And I think a lot of that growth will come from cutting-edge ETFs – the kind that allow you to take your portfolio a step further and essentially, “trade like a hedge fund.â€
Now, before we get into the details, I want to make it clear that these kinds of investments aren’t for everyone. And they’re definitely not for the faint of heart. But I think you should be aware of these emerging products because they’re only going to get more popular, and more mainstream, over time. Here are four of the most interesting categories …
Short/Double Short ETFs: You may not have heard of ProShares Advisors LLC. But this company has already put out a handful of extremely innovative new products. For example, ProShares’ short/double short ETFs allow you to go “short†the market with ease.
A quick recap of shorting: When you short a stock, you’re borrowing shares from someone else at a particular price. If the stock falls while the shares are on loan, you can return the stock to its rightful owner and pocket the difference. If the stock rises, you stand to lose money.
With these ETFs, you can avoid that hassle. All you have to do is buy the ETF, and it goes short the market for you. That makes these ETFs a great hedge against a falling stock market.
For example, if you think the Dow is heading down, you can buy the Short Dow30 ProShares ETF (DOG). Want to bet that the Nasdaq 100 will take a header? Try buying the Short QQQ ProShares (PSQ).
You can even get more aggressive if you’re so inclined! ProShares has “UltraShort†funds for the Dow (DXD) and the Nasdaq 100 (QID). These ETFs are designed to rise 2% for every 1% decline in the underlying index.
Foreign ETFs: Many of you have probably never been to Malaysia, much less thought about buying stocks there. But did you know that you can snap up 61 of that country’s leading stocks in one fell swoop?
All you have to do is purchase the iShares MSCI Malaysia Index Fund (EWM). It holds Malayan Banking, Tenaga Nasional, Gamuda, Malakoff, and a bunch of other banking, industrial, and utility firms.
Heck, you can buy an ETF focused on Brazil … Belgium … even South Africa! There’s an incredibly hot Chinese ETF that the editors of ETF Power Trader have been recommending. It holds the top 25 Chinese stocks, and it’s up more than $20 a share in just a few months.
Many of these foreign ETFs have left U.S. stocks in the dust. The falling dollar is one reason. Stronger economic growth overseas is another. That just goes to show that diversifying your portfolio with overseas investments can really pay off!
New Commodity ETFs: Our Safe Money Report subscribers have been holding one of the gold ETFs for a long time … and it’s been very good to them! Called the streetTRACKS Gold Trust (GLD), it hit the market in late 2004.
Since GLD’s debut, we’ve seen a new commodity ETF roll out for silver (in April 2006) … and heard whispers about one for platinum. And that’s just the start.
For example, there are now two new ways to buy oil – one ETF, the United States Oil Fund (USO) rolled out in April 2006. Another so-called exchange-traded note (like an ETF with slight differences) hit the market this past August.
Then at the end of November, a firm called Claymore Advisors rolled out a pair of more exotic oil ETFs called Macroshares Oil Up (UCR) and Macroshares Oil Down (DCR).
Based on the names, you might think these ETFs go long and short on oil, but it’s actually something far more interesting. The two ETFs own U.S. Treasury bonds, and shift those assets back and forth depending on whether oil prices are rising or falling. Confused? Well, let me explain in more detail:
The combined price of the two funds is designed to add up to roughly $120. So let’s say oil is at $60 a barrel. Both ETFs would trade at $60. If oil were to rise $20, the value of UCR would climb about $20 to $80. The value of DCR would drop about $20 to $40.
It’s a unique approach to playing the oil market without buying or selling oil futures, and without technically even owning a stake in the underlying asset! [Editor’s note: For more information on these funds, see Claymore’s website.]
Currency ETFs: To many investors, currency trading is as exotic as it gets. That’s because, historically, trading currencies has taken a lot of effort.
In the past, if you thought the euro was going to rise in value against the dollar, you had two main ways to play it:
- You could go to a bank that trades currencies and swap your greenbacks for euros.
- You could open a foreign exchange trading account.
Now, you can also forget about all that and just buy the Euro Currency Trust (FXE). A firm called Rydex Investments rolled this puppy out in June. Here’s how it works:
The ETF’s price is roughly equal to the euro/dollar exchange rate times $100. For instance, a price of $132.98 would mean that the current exchange rate is roughly one euro for every 1.33 dollars.
If the euro rises against the dollar, the ETF’s price will go up accordingly.
Of course, you’re not limited to trading the euro, there are similar ETFs for everything from the Mexican Peso (FXM) to the Australian dollar (FXA).
Lots of Opportunity, But
Lots of Potential Risks, Too
You’ve got all kinds of new ways to make money with your regular, plain-vanilla stock trading account. You can place diversified bets on currencies, stocks, commodities, and more – just like the hedge funds do.
But these new exotic ETFs can also introduce all kinds of new risks into your portfolio. Just three of them:
Currency risk – With ETFs focused on currencies or foreign companies, you face the danger that exchange rates will negatively impact your investments.
Example: If you’re investing in British companies via a U.K. ETF, and the dollar gets stronger relative to the British pound, you stand to get fewer dollars back when you cash out.
Liquidity risk – Some of these newer ETFs have little trading volume and a very short track record. So investors might have a difficult time trading a particular investment because of a lack of marketability.
Example: If you’re holding a stock, and only 2,000 shares a day change hands, you might not be able to get out of the position quickly or easily without having to accept a much lower price than the current level.
Derivatives risk – Many of these new products use derivatives to achieve their investment goals. That makes them inherently riskier than a plain vanilla ETF that just owns a basket of stocks.
Example: A short or double short ETF might use futures, options, and forwards to achieve its targeted return.
Bottom line: You have to know what you’re getting into, and be prepared to deal with the risk of loss. These new exotic ETFs can be powerful tools, but spend some time familiarizing yourself with them before you jump in.
Until next time,
Mike
P.S. For more information on the inner workings of ETFs, along with strategies you can use to maximize your potential profits, check out Sean Brodrick’s report, ETFs Made Easy.
About MONEY AND MARKETS
MONEY AND MARKETS (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Sean Brodrick, Larry Edelson, Michael Larson, Nilus Mattive, and Tony Sagami. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Regular contributors and staff include John Burke, Amber Dakar, Wendy Montes de Oca, Kristen Adams, Jennifer Moran, Red Morgan, and Julie Trudeau.
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