I got inspired, in part, because yesterday CNBC asked me to
make three ETF picks for 2011.
It was a fun segment, but time is short in TV and it's hard to
make a nuanced argument. So I thought I'd lay out the full case for
my choices here.
1) China - Using GXC:
China is the world's economic powerhouse, and no global recovery
will take place without it. And yet, after a pullback,
Chinese stocks are cheap. The SPDR S&P China ETF (NYSEArca:GXC)
currently trades at a P/E of 13.8, compared to 15.7 for the SPDR
S&P 500 ETF (NYSEArca:SPY). It's also trading at a 25
percent discount to Brazil, a more comparable economy. Plenty of
people smarter than me are calling for another strong year for
China - Credit Suisse has made non-Japan Asia its No. 1 call for
2011, and I think they're right.
Add in the fact that most people are systematically underweight
China because it's under-represented in global indexes - China
currently makes up a smaller percentage of the MSCI All Country
World Index than Switzerland --- and you see why an extra
allocation to China makes sense.
But most people go about this the wrong way. By far the dominant
China ETF is the FTSE China 25 Index Fund (NYSEArca:FXI), which was
first to market and currently has almost $8 billion in
assets. People who want China buy FXI reflexively. But FXI's
portfolio only holds the 25 largest companies in China - the
biggest of the big - meaning it mostly holds state-owned giants
like PetroChina that export goods to the West. If you want to buy
into the internal dynamism of the Chinese economy, a fund like GXC
that includes exposure to mid- and smaller-cap companies is a
better bet. An even more adventurous bet would be the
Guggenheim China Small Cap ETF (NYSEArca:HAO).
Commodities - Using USCI
The case for commodities is slightly more nuanced. Commodities
have been in a systematic bull market for a number of years, and
those trends appear to be intact.
But what's interesting to me is the fact that oil futures, after
years of trading in contango, have been flirting with backwardation
recently. They're not all the way there, but they're close.
Backwardation is a sign that the supply/demand balance has tipped
in favor of demand; it denotes scarcity in the markets. And that's
bullish for prices.
My favorite play in this market is one of the newer funds, the
United States Commodity Index Fund (NYSEArca:USCI). USCI is based
on an index strategy developed by Yale Professor K. Geert
Rouwenhorst, the father of modern commodity indexing, who
co-authored the landmark paper, "Facts and Fantasies about
Commodities Futures" with Gary Gordon and revealed commodities as a
viable new asset class. This is the kind of strategy that used to
get wrapped up in a hedge fund and billed at "2 & 20"; now it's
available in an ETF and costs 0.95 percent per year.
The returns since it launched in August have trumped all other
broad-based commodity ETFs.
That advantage may shrink in 2011, and there are markets where
it will underperform, but as a long-term holding in commodities
it's a strong choice.
3) Anything but VXX
$327 million flowed into the iPath S&P 500 VIX Short-Term
Futures ETN (NYSEArca:VXX) on Monday. It will all be sacrificed on
the altar of the angry, voracious, money-eating god of
VXX has been a wonderfully efficient way for investors to lose
money in 2010. Through yesterday, investors poured over $2 billion
in cash into VXX, and yet the fund currently has only $1.1 billion
in assets under management. Anytime those two numbers are reversed,
you know something bad is happening, and that's definitely the case
The contango in VXX wipes away any chance investors might have
had. Because of that killer curve, second-month contracts on VIX
are 6.7 percent higher than first month. If the curve stayed this
way, the contract you buy at $22 today, you'll have to sell at
$20.60 next month - that's the butcher's bill. If you had to
repeat that over 12 months, you'll lose a lot more - 82 percent
of your original investment.
Almost anything is better than VXX - you probably have a better
chance of return by handing money out to strangers and waiting for
some karmic return of your generosity. But if you're really
interested in playing volatility, make sure it's for the right
reasons. As a short-term hedge for near-term volatility, VXX can be
a valuable tool. For long term investment strategies, however, it's
This has been an an amazing year for exchange-traded funds, and
2011 should be even better. The three funds I chose here are what
I'm looking toward, but there are plenty of great funds and smart
choices out there. What are some of yours? Let us know in the
Don't forget to check IndexUniverse.com's ETF Data
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