New ETFs: Metals and MLPs

July 5th, 2012
in contributors

Article of the Week from Investing Daily

by Guest Author Ben Shepherd

precious-metalsSMALLJune had been a slow month for new exchange-traded fund (ETF) launches until the last week when five new ETFs came to market.

United States Commodities Fund launched a metals ETF geared toward minimizing the effects of contango and offering exposure to both precious and industrial metals.

Follow up:

United States Metals Index Fund (NYSE: USMI) holds a basket of 10 metal futures contracts including gold, silver, platinum, palladium, aluminum, zinc, copper, nickel, lead and tin.

Each metal is assigned an equal base weight, and then those metals deemed to be in a low-inventory state are given an overweight allocation. The three metals exhibiting the greatest backwardation on the futures curve and the two displaying the greatest price momentum will have their weightings boosted 3 percent above their base allocation. The weightings for the remaining metals contracts will then each be reduced by 3 percent. The fund’s allocations will be rebalanced monthly.

The fund’s annual expense ratio is 0.70 percent, so it’s a fairly inexpensive option for gaining exposure to the entire metals complex in a single shot. The one potential drawback is that it’s structured as a commodity pool, which means investors will receive a K-1 form at tax time. Although a K-1 is not as complicated as some might assume, many investors avoid securities that require them.

State Street Global Advisors launched two new bond funds under their popular SPDR brand: SPDR Bank of America Merrill Lynch Crossover Corporate Bond ETF (NYSE: XOVR) and SPDR Bank of America Merrill Lynch Emerging Markets Corporate Bond ETF (NYSE: EMCD).

The emerging markets corporate bond fund holds dollar-denominated corporate debt issued by companies domiciled in developing countries. But its portfolio won’t be constructed from debt bought on local exchanges, instead focusing on bonds that trade in the US and European markets.

The fund offers the potential growth entailed by emerging markets exposure, while limiting currency risk. A number of recent studies have shown that currency risk often impairs investment performance for long-term investors. So products that reduce the effects of foreign currency exposure are becoming increasingly popular.

The ETF’s portfolio also holds mostly higher quality debt with an average credit rating of BBB. About a quarter of assets will be allocated to securities rated A or better, with a similar weighting for those rated below B. About half of the fund’s holdings are rated around BBB.

The fund charges a 0.50 annual expense ratio, which makes it cheaper than WisdomTree Emerging Markets Corporate Bond Fund (NYSE: EMCB), its only direct competitor. The fund should yield between 5 percent and 6 percent.

The Crossover Corporate Bond ETF takes a more unusual approach for a bond fund, with a blended credit quality achieved by splitting its assets between low- and high-quality bonds. That makes it an excellent candidate for a core bond holding without merely mimicking a total bond market fund.

The fund is well diversified across 3,000 individual issues that have an intermediate-term average duration. The ETF has a 0.30 percent annual expense ratio and should yield around 5 percent.

Huntington Asset Advisors also got into the action last week with its launch of Huntington EcoLogical Strategy ETF (NYSE: HECO).

The environmentally conscious fund invests in companies that generate at least one-third of their revenue from businesses that are either ecologically friendly or pursue measures to help the environment. As a result, its portfolio is an odd mishmash of businesses, including Starbucks (NSDQ: SBUX), Johnson & Johnson (NYSE: JNJ), T. Rowe Price (NSDQ: TROW) and Hain Celestial Group (NSDQ: HAIN) among others.

While I’m not opposed to socially responsible investing (SRI) in principal–in fact, I’ve recommended a number of SRI funds over the years–this particular ETF could pose a problem for investors attempting to assign it a proper place within their overall portfolio.

SRI screens are best applied within the context of a broader investment strategy, such as taking a value approach to large-cap stocks or investing for growth in small caps. But this fund’s portfolio won’t fit comfortably in any investment sleeve since it doesn’t focus exclusively on clean-tech companies or large-cap firms that are good environmental stewards. Another added wrinkle is that it can invest up to 35 percent of its assets in the American Depositary Receipts (ADR) of foreign companies, so its portfolio will have a mix of foreign and domestic stocks.

And with a hefty 0.95 percent annual expense ratio, most investors would be better served by steering clear of this fund. The relatively high expense ratio could also be a hurdle to asset accumulation, which might ultimately make the fund uneconomical for its managers, another added risk for investors.

The final new launch of June comes courtesy of First Trust Advisors.

First Trust North American Energy Infrastructure Fund (NYSE: EMLP) actively manages a basket of about 50 master limited partnerships (MLP), Canadian energy partnerships, and utilities that generate at least half their revenue from infrastructure assets such as pipelines or storage facilities.

These sectors have been of particular interest to investors of late, as they offer higher-than-average yields in a low-rate environment; the average MLP currently yields about 6 percent, while Canadian energy partnerships yield slightly more than 5 percent. They’ve also been attracted by news of the intense activity to exploit the Canadian oil sands in order to ensure North American energy security and the corresponding build-out of energy infrastructure.

While the fund’s diverse approach to this niche is attractive, its 0.95 percent annual expense ratio is not. Although the fund’s managers will make strategic and tactical asset allocation decisions, it’s difficult to imagine they will add sufficient value to justify that cost when other broad MLP funds have expense ratios as low as 0.40 percent.

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