US investors looking to make a bet on companies in Kazakhstan or Qatar are getting help from an exchange-traded funds industry that is increasingly adding single-country ETFs to their offerings.
Some 30 new single-country ETFs came to market last year focusing on markets ranging from the United Arab Emirates to South Korea and China. That brings the total to 202 single-country ETFs with $97.2 billion assets in the United States, more than double the number of funds that existed five years ago. Dozens more - including one aimed at Kazakhstan - are in registration with the US Securities and Exchange Commission.
Darshan Bhatt, chief investment officer of Jersey City, New Jersey-based Glovista Investments LLC, which manages about $1.1 billion, picked Vietnam as a good place to invest, based on its growth potential. Last year, Bhatt bought shares in the Market Vectors Vietnam ETF.
"It's important for us to have these single country funds," said Bhatt, whose firm runs a strategy that seeks to outperform the MSCI Emerging Markets benchmark index, which can involve turning to "off benchmark" nations like Vietnam that they favour.
The fund includes Vietnamese companies including food processing firm Masan Group Corp, property conglomerate Vingroup and Sacombank.
Still, focusing on a single market overseas can carry risks and requires monitoring. Government restrictions can limit the supply of securities available to US fund managers, and the funds' pricing can be unpredictable because they can trade all day on US exchanges while the markets they track are closed.
As a result, the ETF prices don't always match the value of their underlying assets, as they do in traditional mutual funds that price once a day. Single country ETFs often sell at either a discount or a premium, and they can hit unwary investors.
The average maximum premium for all single-country ETFs was 3.2 percent, while the average maximum discount was -2.9 percent, over a 12-month period, according to a Reuters analysis of data provided by ETF.com. By comparison, the maximum premium at the SPDR S&P 500 ETF, a major US domestic ETF, was 0.14 percent and its maximum discount was -0.08 percent.
Premium and discount trading in international ETFs is the result of a simple timing issue. Once an overseas market closes, say Japan, the value of the underlying Japanese assets stay the same, while the US-listed ETF keeps trading. That means that for most of the US trading day, the US-listed Japanese ETF is trading based on expectations of how the underlying market is going to perform the next day.
"As the day goes on, the net asset value (NAV) gets more and more stale," said David Garff, president of Walnut Creek, California-based Accuvest Global Advisors, which invests in a range of country ETFs.
A 1 or 2 percent premium or discount is not alarming on a typical trading day, but a surprise economic policy announcement or unforeseen event could make those premiums double or triple, analysts said.
When the Bank of Japan made a surprise announcement on Friday, October 31, last year that it would be expanding its massive stimulus spending, the iShares MSCI Japan ETF spiked to a 6.8 percent premium on the following Monday, November 3 - a day that Japanese markets were closed for a national holiday.
Investors can take advantage of those price divergences, by using discounts as opportunities to buy into markets they like anyway, Glovista Investments' Bhatt said. But unaware investors may get stuck paying a premium for an ETF without even understanding that they are doing so.
One afternoon last year, for example, Bank of America Merrill Lynch received an order for $1 million worth of shares of the iShares MSCI Japan ETF, at $12 a share - a price that included a 2 percent premium because investors were expecting Japanese shares to rise overnight.
Japanese stocks did rise but the ETF did not move up with it - that bump had already been priced in by US buyers. "We had to explain that the ETF was projecting the premium already," said Sanjay Chablaney, director of ETF trading at BofA, at a conference.
US investors also have to consider currency exchange rates given the stronger dollar, which can cut into total returns generated in weaker local currencies abroad.
Investors have been turning to currency hedged ETFs, which strip out the effect of a region's currency on the performance of a given fund.
The difference can be substantial. The iShares Currency Hedged MSCI Germany ETF, for example, has had a 22 percent YTD return so far in 2015, compared to a 7 percent YTD return for the unhedged iShares MSCI Germany ETF.
Government restrictions in overseas markets, such as taxes or limits for offshore investors, can also add a layer of uncertainty to single-country funds as they can create a prolonged period of trading at a premium. That's because a surge in investor demand in an ETF that can only create a limited number of shares a day may cause a fund to diverge from the true value of its underlying assets.
Deutsche Bank AG, for example, had to limit creations in its China A-Shares ETF late last year after nearly maxing out on its government-issued quota, which caused the fund to trade at a fairly consistent premium of several percentage points for most of late last year before reaching a maximum of 7.2 percent premium in December. It last traded at just under a 1 percent premium.
Because these price disparities can be extreme and because certain markets are not liquid enough, investors shouldn't count on every single-country ETF in the pipeline making it to market. Van Eck Global, one of the largest US providers of single country funds, has had a Saudi Arabia ETF in filing since 2012. But with tight Saudi restrictions on foreign investments that limit access to US fund managers, they have not yet been able to receive the go-ahead from US regulators.
"We are just ready and waiting," said Van Eck Global's ETF product manager Amrita Bagaria. "A lot of people believe the Saudi market will finally be open to foreign investors sometime this year."
Comments
Comments are closed.