ETFStall

We’ll come to the new active ETFs later but first of all I was intrigued to come across an article on passive funds in the Wealth Management Special Supplement to the January edition of Money Observer.

The article, ‘Get the Right Fit on Risk and Costs’ actually has some fairly mainstream recommendations about mixing passive and active funds (not just active ETFs but mutual funds, too).

What wasn’t unexceptionable was the version of recent ETF history that you might infer had taken place. The article says that are not based on in-kind replication (those that are not physically backed in other words) are by far the most common. Putting that way makes it sound as if finding ETFs that invest in the assets in the index that’s being tracked is really hard and, it’s true; if you choose your funds with a drawing pin and your eyes shut, you are more likely to come across a synthetic ETF than one based on in-kind replication. But there are plenty of the latter out there and there are ETF sponsors such as HSBC, iShares and Invesco Powershares that focus exclusively or mainly on in-kind replication. Finding physically backed ETFs is really not that difficult.

My second beef with this article is the language used in describing synthetic ETFs; replicating the performance of the index through the use of derivatives. This is perfectly true but what’s missing from the statement is the useful qualification that nearly all synthetic ETFs use just one basic kind of derivative, a swap. The article then goes on to explain the collateral risks of synthetic (or swap-based, as I prefer to call them) ETFs and here, too, the explanation is on the simple side of genuinely helpful. There’s no mention of the UCITS requirements for collateral risk to be kept to within 10% of level of the assets being tracked or of the fact that in-kind ETFs are also exposed to collateral risk through their sponsors stock lending activities. These two facts almost seem tired after the coverage they had in 2011 but it looks as if there’s good cause to keep on trotting them out.

This kind of treatment lends weight to financial advisers case for their own indispensability but, if someone is ready to put in the ‘leg-work’ of reading Money Observer in the first place, getting a better grip on the essentials of the ETF industry really shouldn’t be that hard.

The first of the two active ETFs that ETFStall is looking at today is an active Russian ETF sponsored by Alpcot Capital Management, Alpcot Active Greater Russia ETF. To begin with the ETF is only going to be listed on Stockholm’s NASDAQ OMX Exchange with further listings depending upon investor interest. The new fund’s approach to the problematic area of disclosure is for some holdings to be disclosed (presumably daily) and others to remain undisclosed roughly in the proportion of 4:1. The sponsor will provide an indicative net asset value estimate through the trading day. The ETF will be physically backed but, presumably, creations and redemptions will have to be at least partly in cash. How active the selection of the disclosed part of the portfolio will be and whether the selction of the undisclosed assets is pure active manager skill or ears close to the ground hearing information otherwise unobtainable remains unclear.

The chilling ‘Greater’ in the name signifies investments will be made in other countries within the Commonwealth of Independent States in addition to Russia. The management fee will be 1.4%.

The second active ETF is probably more trend setting as it crystallises the idea of an ETF of ETFS. The db x-trackers SCM Multi Asset ETF will invest in other ETFs under the guidance of the ETF asset allocation specialist company, SCM. The expense cost of the ETF will be 0.89% and this is inclusive of the aggregate total expense ratios of the underlying ETFs.

And to return to my starting point, the supposed difficulty of ETF investing: active ETFs are outside its main subject focus so ETFStall has no opinion to offer except to say that this is an area where financial advisers really do have a part to play.

Once more ETFStall apologises for the long delay in posting, the more so as this particular post is supposed to be part of a regular series; a four monthly look at the performance of some of the ETFs that have been mentioned in this blog previously.

Last time I wrote a watchlist report**, I was hopeful that there would have been some recovery after another four months had elapsed. In the event, my optimism has been proved justified; better justified perhaps than my bout of Eurozone blues back in December.

The key points that emerge in this update on the prices of ETFs on the ETFStall radar are, firstly, that the picture is looking a lot brighter. To an extent, I’m taken aback by just how much better the picture is looking. There really are very few ETFs in the Watchlist that have fallen in value in the October-January period (just three in fact) and none of these isolated ‘losers’ have fallen by as much as two per cent.

The second point is that, although the picture is almost universally brighter, the gains of the autumn and winter have not made up for the losses of last summer. Generally, speaking the effect is like a cyclist free-wheeling downhill but only making half way up the next hill before they have to start pedalling again. The only ETFs to be up on their price of eight months prior are iShares euro Corporate Bond ETF, iShares Global Index-linked bond ETF, db-x-trackers Sterling Money Market ETF, iShares Aggregate Bond ETF, ETFS Physical Gold, iShares Barclays euro Treasury Bond ETF, iShares S&P 500 ETF and iShares Markit iBoxx Corporate Bond ex-Financials ETF. The sole equity ETF in this group, iShares S&P 500 ETF ( IUSA:LN ), was also the only one of them to be recovering from a drop in price.

So, although on a superficial level the Watchlist results look encouraging, perhaps they should make us pause to consider. Although the recovery hasn’t completely offset the falls of summer 2011, like the falls but to an even greater extent, the price rises have been almost across the board. So what we are seeing is herd-like behaviour to a marked degree. The twin pillars of optimism that seem to be having the most effect are growth in the US and some relief about the path of Europe’s sovereign debt crisis. Neither of these effects are rock solid causes for optimism. While the US’s economy may be recovering, it would have to be a lot, lot stronger to make America’s own sovereign debt problems go away. And while we may be getting used to the idea that the Eurozone is built on flawed foundations, chronic weakness for such a large component of the World economy is hardly a cheering thought.

With this broad spectrum cheer and signs of growing correlation in the Watchlist, I’m inclined to think that everything is speculative at the moment, not just physical gold funds.

In terms of the performance of different types of asset, dividend ETFs have generally performed poorly. iShares DJ EURO STOXX Select Dividend ( IDVY:LN ), iShares UK FTSE Dividend Plus ( IUKD:LN ), ETFX DJ Global Select Dividend ( GDIV:LN ) and SPDR S&P US Dividend Aristocrats ( USDV:LN ) rose by 3.63%, 5.93%, 7.86% and 1.84% respectively. I include GDIV in the list for poor performance because, as an accumulating fund, some of its increase in price is accounted for by re-investing dividends rather than improved prices for the underlying stocks. iShares DJ Asia/Pacific Select Dividend 30 ( IAPD:LN ) and iShares Emerging Markets Dividend ( SEDY:LN ) did better with price rises of 6.33% and 6.25% respectively. These two both distribute dividends.

Speaking of dividends, Morningstar published an excellent article last week; ‘Breaking Down the Different Yield Calculations,’ by Timothy Strauts. This looks at the strengths and pitfalls of the common methods of measuring dividend yield, mainly with reference to bond funds. There’s a link here: http://www.morningstar.com/articles/author/1536-timothy-strauts.aspx .

The best performers were Lyxor ETF Brazil Bovespa ( LBRZ:LN ) with a 24% rise and db X-tracker MSCI Russia Capped ( XMRC:LN ) with one of 19%. ETFS DJ STOXX Basic Resources, which was worst performer last time, might have been the best performer but it appears to have been delisted. I’ve added db X-tracker DJ STOXX Basic Resources ( XSPR:LN ) to the Watchlist; that fund rose by 25% in the four months under review. Another ‘producer’ ETF, db X-trackers DJ STOXX 600 Oil & Gas ( XSER:LN ) almost made it into the exclusive club of ETFs that recovered to their price level as of end-May last year, with an 18% rise. While ETFX S-net ITG Global Agri Business Fund ( AGRI:LN ) also performed very well.

With the exception of iShares MSCI Japan Small Cap ( ISJP:LN ), which registered the biggest fall in the period of any on the Watchlist, all the ETFs for small cap stocks performed well.

** The Watchlist figures can be found on the Watchlist section of www.ETFStall.co.uk

Apologies for delaying so long before posting again. ETFStall has had a flying visit to Lake Constance on business entirely separate from ETFs.

In my previous post I said that we’d be taking another look at gold funds. It’s been over six months since I last focused on gold exclusively although I did mention that in the midst of the summer rout in asset prices, gold was one of the types of fund to maintain its value. At the time of writing (early October), gold had just experienced its steepest price decline for a years and a view was forming that sentiment was turning against the precious metal. Since then the price of gold has recovered (in November), fallen again (in December) and recovered again – somewhat – since Christmas.

The point about gold is that it seems to defy a lot of the analysis that investors attempt to apply to it. One could say that it’s a blatant demonstration that what people believe in that matters, a case of the emperor’s new clothes. And this missing genuine rationale makes a lot of investors and commentators queasy. Nevertheless, with interest rates so low, much sovereign debt looking so risky and the likelihood that some governments may want to inflate their currencies to reduce sovereign debt, it’s not such a great mystery that gold has re-established itself a store of value.

The question is, how enduring this status is likely to be? To which the answer seems to be until more genuinely productive investments look more attractive, at which point most current holders of gold will head for the exit. Can’t say when that will happen except that the time hasn’t arrived yet.

In the meantime some commentators continue to knock gold for a variety of reasons. Other precious metals such as silver or platinum are recommended because they leave gold trailing in the dust when it comes to utility but the fact remains that during the credit crunch gold fared better than platinum.

Another recent clever theory from the unbelievers’ camp is that some hedge funds such as Paulson & Co. having stocked up on gold a few years ago may now need to sell a lot of it off to stay afloat (‘Gold Feels Weight of Paulson Curse’, by Jack Farchy, FT 09.01.12). If that turns out to be true it’s a timely reminder to keep clear the distinction between believing in gold oneself and taking notice of whether or not other people are gold believers.

ETFStall’s next post will probably be an update to the Watchlist, sometime next week.

ETFStall will start this post with a look at the fresh thinking that came out this week from the Edhec-Risk Institute, saying words to the effect (none of my sources provided links to the full text but readers might like to follow this link:- http://www.edhec-risk.com/features/RISKArticle.2012-01-17.5319 ) that last year’s banging on about the differences between ETFs based on physical replication and the swap-based variety was overwrought. These clever people also spotted that BlackRock had being saying different things about ETF nomenclature to regulators in Europe and the US.

Given time, ETFStall will have a look at the full text of the Edhec position paper ‘What Are The Risks Of European ETFs?’ and report back.

Basically, I think EDhec Risk Institute are right to sound a note of caution to counteract some of the scary things that have been said about swap-based ETFs. However, from the point of view of the private investor the whole debate seems designed to obfuscate and has become a lesson in how much comment aimed at shaping lay opinion is polluted by commercial interests working in disguise.

Moving on to new ETFs, there are two particularly important developments so far this month. Firstly, as expected, PIMCO, the world’s leading fixed income fund manager has launched an ETF ‘version’ of its Total Return Fund. While not surprising and happening on the other side of the Atlantic, this is an important development for ETFs and fixed income investing.

The new ETF will be called the PIMCO Total Return Exchange Traded Fund ( TRXT:US ). It will have a TER of 0.55%. Like the it’s mutual fund big brother, it will be an active fund but it will differ from it in making daily disclosure of its holdings and because it will be restricting itself to bonds pure and simple; the mutual fund can invest in derivatives. It’ll be interesting to see how such a high profile active ETF that adheres to daily disclosure of its assets fares. My first thought is that this is going to act as a kind of running commentary on the bond markets, silent signals like semaphore, so to speak.

The other important development has more relevance to most UK domiciled investors as it involves the launch of a new ETF on the LSE. This is a collaboration between Legal & General and Source to launch the LGIM Commodity Composite Source ETF ( LGCF:LN , the sterling version* and LGCU:LN the dollar one). As with some European domiciled PIMCO ETFs, Source is the partner of choice.

The new ETF is UCITS-compliant but has a management fee of 0.40% and a swap fee of 0.45% so it isn’t cheap. The novel feature of the new fund is that it tracks (currently) four different commodity futures basket indices rather than one (so, presumably, the management fee must include quite a lot of index fees). The four indices are:

Citi CUBES (DJ-UBSCI Weighted) Index Total Return
Barclays Capital Commodity Index Pure Beta TR
UBS Bloomberg Constant Maturity Commodity Index
JPMCCI Ex-Front Month Energy Light Index (Total Return)

The fund will rebalance back to equal weighting of its constituent sub-indices each quarter. However, the fund reserves the right to change the sub-indices that it employs and even to adjust the number of sub-indices (though to no less than three indices). Having looked at the simplified prospectus, I can’t see a reference to management risk but this ability to switch sub-indices is an active ingredient.

Looking at the overall current index constituents, there are 30 of them overall with energy futures of one kind or another representing 36% of the total approximately. This is a low energy component compared to most commodity basket indices, which seems like a sensible approach.

Legal & General managing a commodities fund might seem surprising but, on reflection, they wouldn’t be able to manage the billions in their equity funds without some views on the commodity markets. Also, Legal & General’s Global Macro Themes fund has been in the top four of the specialist category of conventional funds over one month, six months and one year and that success must be derived partly from understanding the commodity markets.

Next, next week probably, ETFStall will return to the subject of gold.

* As we’re talking commodity exposure here the base currency is, of course, the US dollar. See my book, ‘Exchange Traded Funds, A Concise Guide To ETFs’ for a full explanation of the ins and outs of ETF currencies.

The FT reported earlier in the week on some research carried out for them by the ETF specialists XTF. This suggested that in the US the years of rapid growth in ETFs may be coming to an end. One of the most interesting findings of their study was the increase in the number of new ETFs that, they say, are failing to attract sufficient assets – 70% of US ETFs launched in the first half of 2011 failed to grow above the level of $30 million of assets (by the end of last year, presumably) compared to a level of 62% last year.

This figure of $30m set as the bar for defining success is a lot less than the $100m suggested by McKinsey in their report on ETFs last summer, “The Second Act begins” ( ETFStall, 18.08.11). This lower figure for defining success seems more realistic and XTF’s analysis that the market is becoming saturated in terms of the dwindling number of assets and indices remaining untracked (hence new launches are becoming more and more specialised) also seems like common sense.

However, six months to a year still seems a remarkably short time span for judging the success of a fund, especially at a time when a lot of existing investments are losing ground and relatively few people are ‘coming into’ money. Personally, I’d allow a new ETF longer to accrue a healthy level of assets under management – maybe two years – and I’d pay more attention to whether or not assets under management (AuM) are gradually rising. As I may have mentioned before ETFexplorer’s data on European domiciled ETFs usually seems to include a handy field for net new money over the previous three months.

I’m not aware of any research into the effect of (relative) high returns on the popularity of a passive ETF. That’s to say the extent to which a passive ETF can achieve popularity when its tracking an asset that happens to be successful. Obviously, it must be much, much higher than the proponents of passive investing would like and so there must be numerous new ETFs that achieve popularity for the wrong reasons.

Another report that caught my eye this week was iShares’ “Through The Looking Glass, ETPs in 2012”. But before looking at some of the stimulating thoughts in their report, let’s digress a little on to the subject of what financial commentators have to say about share valuations and, in particular, price earnings ratios (P/E ratios). These are bread and butter to writers of investment forecasts.

The basic idea of a share’s price earnings ratio seems straightforward enough but it’s worth bearing in mind that the concept has been refined in a number of directions and the result is that it is often difficult to compare the work of different forecasters.

So, firstly is the commentator looking at the most recent P/E ratio (ie., based on the most recent earnings figures) or might she/he be using a forecast earnings figure for the next results (P/E FYI)?

Alternatively, the commentator may be using the Shiller P/E ratio, which takes the cyclically adjusted (that is, it averages them) earnings over a ten year period and calculates the P/E based on the latest price. Now, commentators are saying that even 10 year time spans are too short for investors to truly appreciate sea changes in the investment climate such as may be happening now.

Unfortunately, forecasts of equity or fixed income returns can be similarly tricky to handle as by the time these predictions come up in media aimed at private investors the exact data used to make the forecast has become obscured. So, for instance, you might read that the forecast returns on UK equities are for an average of 5% over the next six years but is that prediction based on current prices or a set of historical valuations and are the UK equities in question the FTSE 100 constituents or a broader index?

So what’s to be done? The disciplined investor would make a note of what is prompting an investment decision and bring it out to compare when forecasts come around. If the commentators seem to putting forward a view that’s radically different from your own leanings, it may be worth re-examining the latter. But be on the lookout for commentators’ own prejudices. If they are tending to agree that large caps are going to beat small caps in the next few years, can that be based on any facts or is it a developing fashion.

Going back to iShares looking glass, they prepare the ground by setting out three scenarios for the coming year along with the probability of them occurring:- slow growth (60%), crisis (35%) and better growth (5%). This looks realistic but one year forecasts can be unduly reassuring; they pander to our desire to take reality in small doses. Imagine if three successive annual forecasts each had the probability of crisis at 35%; the likelihood of another crisis in the three year period would be more like 100%. So slow growth but maybe slightly better than we’re expecting may well be what’s in store for 2012 but the likelihood of further crises in 2012 to 2015 looks pretty strong, too.

On top of the three scenarios iShares a further five scenarios with ‘divergence’ (some emerging markets moving away from the rest of us) and ‘nemesis’, the most likely two, scoring probabilities of just under 50% and just over 20%, respectively.

The suggestions that follow on are for a core strategy of investing in high dividend, mega caps and gold. On top of that they’re suggesting you choose your economic prediction, divergence or nemesis, and add either equities from Canada, Australia, Switzerland, Singapore and Hong Kong (or CASSH), equities from emerging markets, ‘energy’ and corporate bonds OR US Treasuries and more gold.

The inclusion of US Treasuries is interesting because one of the components of the nemesis scenario is a US Treasuries buyers’ strike. Given the appearance that some US politicians gave of being willing to countenance a government default last summer, perhaps a buyers’ strike isn’t so unrealistic (or undeserved). Or perhaps, with Mitt Romney as the likely contender for the presidency, a US default is out of the picture.

The CASSH option is also interesting. The acronym, which is new to me, is for five smaller developed markets that iShares reckons are more appealing than the larger ones. Given that combined the CASSH countries have a smaller population than the UK, it’s slightly sobering to see such hopes being placed upon them. But, of course, geographical size is more of a factor for some analysts* and, overall, CASSH certainly has plenty of that. iShares’ CASSH idea is interesting, too, because they don’t actually sponsor a CASSH ETF so the implementation relies on using four ETFs with very high correlation with the CASSH component countries. I’m sure that the reliability of correlation for predictive purposes has been researched exhaustively but somehow I can’t help thinking that it’s snare.

Lastly, with the energy suggestion, iShares seem to be recommending energy stocks rather than energy ETCs or energy futures ETFs.

Next week ETFStall hopes to look at a couple of important new launches that have taken place this year.

So while agreeing with most of iShares forecasting, I’m more choosy about the ETF recommendations. I can see the importance of gold, high dividends, energy and emerging markets but I’m more sceptical about fixed income and mega caps.

One thing is for sure; by this reading Blackrock seem pretty committed to their ETF family.

*Personally speaking, Geographic space seems an unwise analytical shortcut.

Having read a few appraisals of the year gone by in ETFs, my own summary of summaries is that it wasn’t a good year for UK and continental investors as far as ETFs were concerned.

The year was dominated by the increased attention that ETFs received from regulatory authorities beginning last spring, and concerns about swap-based ETFs and their counterparty risks in particular.

Some of the issues raised were helpful pointers to private investors but in the mian the effect was to muddy the waters significantly. As far as swap-based ETFs were concerned the muddying occurred partly because the authorities couldn’t be seen to be pointing the finger at particular institutions sponsoring swap-based ETFs. However, investors were helped to join the dots by the relentless bad economic news coming from the Eurozone members. It wasn’t difficult to see that banks over-exposed to euro sovereign debt and banks acting a the sole swap counterparty for their own ETFs must be overlapping to some extent: the only other thing investors needed to know was which ETF brands were sponsored by which bank.

Apart form that confusion reined for private investors. Regulators took aim at possible ETF dangers to investors and their possible threat to the financial system as a whole. ETFs were singled out for negative treatment for practices, such as stock lending, that are common among conventional investment funds, too.

The response on the part of ETF sponsors was to the make heavy use of the regulators’ output as ammunition against one another. Some of this was helpful; for example, when attention was drawn to their superior levels of transparency about the contents of collateral baskets by the likes of iShares. Not so helpful was iShares ideas about the right way to classify (ETF Securities’) family of exchange traded commodities.

Given the testing times that have overtaken the ETF industry in 2011, one of the most worrying trends was the failure of several ETF sponsors to do anything to improve their Internet presence. ETF sponsors generally have lost the initiative in informing the investing community about their own products. A number of sponsors have always seemed more interested in web design that passing on information to investors but, given the challenges of 2011, it’s surprising that they didn’t do more to help themselves in this area.

Not surprising, in consequence of all this, was the field day enjoyed by critics of ETFs such as Terry Smith. There’s no doubt that the ETF concept has taken a knock. Another consequence is likely to be a loss of prestige or authority for UCITS. Questions are being asked about whether the way in which funds comply with UCITS is really in the spirit of the protection that UCITS was originally intended to provide. In this UCITS could be a victim of its own success but one result will be a loss of trust in UCITS as a way of delimiting a moderately safe area for private investors to operate in.

IndexUniverse has identified a bifurcating tendency in US ETFs in 2011 with sponsors such as Vanguard gaining significant ground for its ETFs tracking the most ‘obvious’ indices by means of ever more competitive pricing while at the same time there are increasing numbers of so-called strategy ETFs, ones that are quantitative active, quasi active or active active. So far, European investors haven’t seen so much of the cut-throat price competition; European sponsors are busy cut each other’s throats but not over price.

On top of all the technical safety issues hanging over European domiciled ETFs at the moment, the sovereign debt crisis has reached such proportions that the natural cornerstone of a European’s ETF portfolio – European equities – has moved into limbo while everyone waits to find out how serious eurozone leaders really are about their austerity policies.

Moving forwards to 2012, private investors might be encouraged by promises to curb boardroom pay made by David Cameron and Chuka Umunna, the Shadow Business Secretary. However, it’s unlikely that anything will be done either to give shareholders who hold their shares through nominee accounts the opportunity to vote at company general meetings or to introduce mechanisms for tracking funds to vote their shares on issues like boardroom pay.

The Financial Times has reported that iShares has submitted filings to the SEC for the launch of four ‘quasi-active’ exchange traded funds (“iShares files for quasi-active suite in the US”, Ignites 27.01.11).

These new ETFs are also described as ‘strategic beta’ funds. The four funds invest in US large caps, US small caps, developed international large caps and developed international small caps. The funds will ‘look’ for high quality earnings and (relatively) low valuations and market capitalisations. In this regard the four funds seem to fall into the quantitative-active category of ETFs.

However, the SEC filings make it clear that the BlackRock Fund Advisors have reserve powers to depart from their own proprietary investment process and the example that is provided is of switching a higher than normal proportion of assets into cash in adverse market conditions.

Given the current climate, that kind of active interference sounds sensible. Nevertheless, these new ETFs mark the furthest departure yet that iShares has made from tracking funds. It seems as if the distinction between iShares and BlackRock is breaking down. Given that Vanguard’s ETFs have generally attracted more inflows than iShares’ or State Street Global Advisors’ in 2011, might BlackRock be becoming disillusioned with its ETF range?

The article doesn’t mention what indices these four funds will be benchmarked against or the total expense ratio will be.

Now we can see the full outline of the EU leaders’ latest attempt at soving their crisis. Germany and France are still on track with plans for austerity and, now, more financial regulation is in the mix, too. David Cameron has had to play his hand in a way that might (but probably won’t) placate his Europhobe MPS and nobody else seems to have spoken up for finding a way back to global growth.

Given that less than a fortnight ago ETFStall was making a case for keeping one’s nerve, it’s only right to say that the argument seems to have been lost. This is one of those times when politics trumps other considerations for investors.

Holdings sold:

Henderson European Smaller Companies Fund
*Powershares FTSE RAFI Europe ( PSRE:LN ) – some but not all
*Powershares FTSE RAFI Dev Europe Mid-Small ( PSES:LN )
iShares Euro STOXX 50 ( EUE:LN )

Still holding:

iShares Euro STOXX Select Dividend ( IDVY:LN ) and some PSRE:LN.

* Although I believe that the fundamental index approach is better than cap. weighting, the small size of PSRE and PSES does give cause for concern.

This post is not specifically about ETFs as opposed to conventional funds or investment trusts, more a cry of regret.

Having been a long-term investor in European equities for a number of years, the outcomes from the latest round of talks between the German Chancellor and the French President has finally prompted a re-think on Tuesday. As a result, I’ve decided to ditch holdings in a number of European equity ETFs and a European equity fund either in part or in their entirety.

For several different reasons the plans for proposed for a rescue of the Eurozone based on fiscal austerity have galvanised me into action. My thinking used to be that whatever the sovereign borrowing problems in the Eurozone and the balance of payments problems in several of its member states, there were a lot of good companies in Europe and that patience in keeping my investments would be rewarded a few years down the road (and in the meantime, the dividend yields would be some consolation for stock market falls).

This is not so much a panic reaction as a puzzled reaction because there seems to be more than one reason why fiscal austerity in the Eurozone seems like the wrong answer; a solution that won’t serve its purpose.

First off, the much spoken dread of currency debasement in Germany. To be sure, a hefty programme of shoring up PIIGS by providing economic stimulus would be a big change of direction but there is really very little in common between now and the German economy in 1923 or 1946. German currency at those points became worthless because Germany wasn’t making anything. By contrast the European Union countries trade with the rest of the world is pretty well balanced and Germany and other core European countries are making plenty.

The really valid comparison that German politicians should be thinking about is the attempts to reduce government deficits as the world economy went into depression in the 1930 (under Chancellor Bruning). Bruning was a very clever man but this chancellorship failed largely because more and more people were losing their jobs and his fiscal austerity only made things worse.

Back in our own time, the idea of fiscal austerity working for heavily indebted Eurozone countries seems implausible. How are any politicians going to be able to lead their voters in that direction once it becomes plain that the economic pain is going to be long lasting. (One kind of fiscal austerity that might have a chance of working is giving holders of sovereign debt some kind of direct claim on the wealth of the country in question. This might be, say, across the board share issues that would dilute the holdings of existing shareholders in companies quoted on the national stock exchange in order to create a fund for meeting claims by sovereign bond holders, plus a wealth tax on all real estate – possibly excepting modest first homes - and privately held industrial plant with receipts being paid into the same fund. Is there any likelihood that any of the PIIGS would do anything so radical?).

Finally, surely, governments have always borrowed and often succumbed to the temptation to borrow more than they should. That’s the depressing truth but to think that it could ever change risks parting company with political reality.

Regular readers of ETFStall may have already spotted that I’m keen on dividend paying ETFs. There are four ‘select dividend’ ETFs on the ETFStall Watchlist, I own some dividend ETFs myself (see below) and this category of fund was covered in some detail on 20th April ( ‘ETFs For Dividends’ ). I refer you to that article for more detailed information as this posting is really just an update on the current state of dividend ETFs.

Sadly, this enthusiasm for dividends hasn’t been a happy story so far. As someone who bought Lloyds Bank shares in 2008 ‘for the dividend’, I know all too well that there’s many a slip twixt cup and lip. Even the iShares EURO STOXX Select Dividend ETF is down by about 21% since the shares were acquired in mid-May 2010. The dividends paid over that period amount to roughly eight per cent of the holding’s original value. The current dividend yield on a trailing 12 month basis is just over 6%, at which rate I would be just about back to where I started in about 30 months’ time (not allowing for inflation).

My main reason for coming back to dividend ETFs now is the appearance of a few new funds in recent weeks, including, most recently the iShares Emerging Markets Dividend ETF ( SEDY:LN ). SEDY tracks the Dow Jones Emerging Markets Select Dividend Index. The best represented country in the index is Taiwan (with 25%), followed by Brazil (13%), South Africa, Turkey and Malaysia. The leading sector is telecommunications (18%) and industrials (17%). Constituents must have positive earnings per share record of just 12 months and have paid dividends in each of the past three years.

This new arrival follows just five weeks after SPDR launched European-domiciled versions of two of its US dividend ETFs, one of which is another emerging markets fund, SPDR S&P Emerging Markets Dividend ETF ( EDVD:LN ). EDVD constituents must have three consecutive years of earnings growth and profitability. As with most of the ‘select dividend’ field weightings are according to dividend yield. As well as having slightly superior selection criteria to SEDY, the TER is slightly lower at 0.59% (compared to 0.65%). EDVD has slightly more holdings, 103 against 97 for SEDY. Although Telecoms again has the highest sector weighting with 21%, the second highest is financials with 19%. The SPDR ETF seems to be following a representative sampling strategy and this may explain why the dividend yield of the index at 7.22% is so much higher than that of the ETF itself at four per cent.

EDVD covers more countries than SEDY, including South Korea as the 4th best represented country and also has a higher weighting of mainland Chinese companies.

The second SPDR ETF to be launched in Europe in October was the SPDR S&P US Dividend Aristocrats ETF ( USDV:LN ). In fact the dividend yield of USDV is not particularly impressive at 3.24% but the selection criteria certainly seem solid enough: index constituents have the 60 highest dividend yields in the S&P Composite 1500 and must have increased their dividends for at least the last 26 years. the most heavily weighted sectors are consumer staples and financials with 19% and 17% respectively, The expense ratio is 0.35%. The ETF holdings seem to be a much closer match to the index make up than with EDVD.

Holdings:
iShares EURO STOXX Select Dividend 30
iShares FTSE UK Dividend Plus