Among The New ETFs Of 2014, These Three Hold Great Appeal

David Sterman's picture

Tuesday, October 28, 2014 - 1:30pm

by David Sterman

It's getting harder to stay abreast of the fast-growing market for exchange-traded funds. For every ETF that closes, another two or three are launched -- we're reaching ETF overload. The industry offered roughly 900 choices in 2009, according to Morningstar, and that figure has swelled to more than 1,600 today.

Still, it's wise to devote time and energy to this asset class. ETF sponsors often look for ways to deliver new and unique investment angles, and some of them appear very well-positioned for long-term upside.  Here are three ETFs launched this year that merit consideration for your portfolio.

First Trust Dorsey Wright Focus 5 ETF (NYSE: FV)
We are big fans of relative strength as an investment theme. In fact, our Maximum Profit newsletter squarely focuses the metric. So does this ETF, which invests in other funds offered by First Trust. The ETF rotates its funds depending on which one are showing the greatest relative strength.

The "fund of funds" approach is starting to gain attraction. Though the ETF got off to a weak start after it was launched in March 2014, it has rebounded: Over the past six months, it's up 12%, compared to a 4% gain for the S&P 500 in that time. That kind of performance helps offset the pain of a too-high 0.95% expense ratio. That pricey expense ratio is explained away by the fact that the portfolio is rebalanced quite frequently, often weekly, if conditions warrant.

As a measure of this ETF's popularity, assets under management has already swelled to $650 million, which is quite impressive when you consider that it isn't sponsored by one of the major ETF players such as State Street or Blackrock. To be sure, this fund has yet to be tested in a bear market, which can often be the bugaboo of RS-based strategies. The fund's prospectus offers no information about back-tested results, which would be helpful for any new fund (and in my view, should be mandated by regulators).

iShares Core MSCI Pacific (Nasdaq: IPAC)
This Asia-focused fund holds appeal for one simple reason: A rock-bottom 0.14% expense ratio (which is similar to many other "iShares Core" funds). Investors have many other investment choices among global ETFs, but many carry expense ratios in the 0.50%-to-1.00% expense ratio. Those expenses can really eat into returns and are just another reason that investors mistakenly underweight emerging market stocks in their portfolios.

This fund doesn't yet have $200 million in assets under management, nor has average daily trading volume reached 100,000 shares. As a result, the bid/ask spreads can be more than $0.05, which means it's a poor trading vehicle and a better tool for long-term investors. It's too soon to know how this fund's portfolio will perform compared to other Asia-focused ETFs.

There is a clear emphasis on companies in Japan and Australia, such as Toyota Motor Corp. (NYSE: TM), Softbank and Australian banks and miners. This is a good thing or a bad thing, depending on your world view. My take: the portfolio composition is appealing, as its focuses on Japanese exporters -- many of whom are benefiting from a weak yen -- and Australian blue chips, which have been out of favor this year due to the slump in commodities. Still, only one stock in the top 10 holdings is focused on that moribund niche.

U.S. Quantitative Value ETF (Nasdaq: QVAL)
This fund just began trading last week and is poised to become an instant favorite of mine. That's because it focuses on stocks that have low enterprise values in relation to their earnings before interest, taxes, depreciation and amortization, which I discussed last week. Better yet, it screens potential holdings for quality of earnings measures, using traditional forensic accounting gauges to weed out companies that pursue overly aggressive accounting policies. One sore point: the 0.79% expense ratio, which will only be justified if this approach proves to handily outperform the broader market. 

An interesting side note: The fund manager, Wesley Gray, is the author of a well-researched book "Quantitative Value: A Practitioner's Guide to Automating Intelligent Investment and Eliminating Behavioral Errors." It's a bit of a wonky read, but very useful for investors that want to learn more about the paired approach of value investing (such as low EV/EBITDA stocks) and quantitative investing (which seeks to automate the stock selection process through rigid criteria).   

Risks to Consider: The biggest concern with any new ETF is the potential that it won't gain traction with investors. If assets under management don't rise and trading volumes remain low, then fund sponsors may eventually pull the plug. As the portfolio is liquidated, realized prices in the asset sales may be less than what investors had expected.

Action to Take --> These three ETFs focus on disparate investment themes or asset classes, but they all share a common trait: outperform existing ETF offerings, either through lower expense ratios or more sophisticated portfolio management techniques.

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David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.