A couple of weeks ago I was invited by the guys at “The Market Traders” to join in on their weekly roundtable podcast as one of three guest panelists.  If you check out their site, you’ll see that they’re big on commodities.  Possibly a bit more of a speculative bent to their site with ads that make me think that it’s a place where stock pickers come to congregate.  However, I was surprised to find that I wasn’t the only one commenting on ETFs and my fellow panelists didn’t really spend a lot of time discussing specific stocks although a few ETFs were mentioned (not just by me).

We basically comment three times:  Once on energy, the second time on the US dollar and finally with thoughts on areas of the market that we like.  Some who have followed my writings and have become accustomed to the way I do things might be a bit surprised by my final comments.  I basically state in explicit terms how I don’t believe now is a time to think like a traditional asset allocator.  I don’t think now is the time to stick to the “60%-equity/40%-fixed income” strategic asset allocation model.  Frankly, to have a “buy-hold” mentality all of the time requires a stomach of immense fortitude.  (What you are hearing now are people from Vanguard and DFA squirming in their chairs.)  Does that mean I’m leaning towards market timing?  On the spectrum, I don’t think I’m at the far end which is market timing, but I’m certainly not at the buy-hold end.  I’d like to think that the “strategic asset allocation” process which I think is so important (cool with that Vanguard/DFA?) should, in this environment as well as others, be allowed to deviate in two ways:

1.  Allow for some tactical asset allocation.  That may mean allowing min/max constraints for asset classes to deviate even more from “home” or what may be defined as the policy allocation.  That may also mean allowing the asset allocation shifts (rebalancing, delaying implementation of cash equitization, etc.) to happen a little more frequently than normal.  This allowance for tactical decisions could actually mean several things but generally I’m saying that I believe some allowance for deviation from standard asset allocation protocols is warranted.

2.  Allow for exposure beyond the traditional asset mix.  This means to make sure that alternative investment exposures are in place.  Is it too late today for gold, oil, agriculture and other commodities that seem to be getting all the attention these days?  They’re volatile (and I believe, getting more volatile) but their diversification properties are undeniable.  Caveat:  I’m talking about exposure to the commodities via ETFs, ETNs or derivatives, not indirect exposure via equities (like gold producers).  I don’t think it’s too late to get into infrastructure and other inflation hedging asset classes and the only question is how much of these alternative asset classes is warranted as a buffer to the core of traditional asset classes (stocks/bonds/cash)?

Buy-hold philosophies for multi-asset class exposures made a lot of sense for anyone from the period of 1980 to now.  The only major hit was 2000-2002.  The big question I ask myself is whether we are still in this secular up market or did that end one year ago.  In other words, are we in a sideways or down market that has the potential to be anything as bad as the 2000-2002 bear market?  My sense is that for broad regional market exposures like the S&P 500 the answer is likely to be yes.  However, for various sectors and foreign exposures, I feel confident the answer will be no.  We’ve come out of an environment where nearly everything did well fueled by a world of cheap money.  That doesn’t mean that the pendulum will swing causing nearly everything to plummet.

A very important consideration is also the role of private equity and hedge funds given my comments above on the importance of alternative investments.  I can’t stress this enough:  As much as I am a fan of passive instruments, I’ve never said that one should completely disregard active management.  Is it hard to pick the successful managers ahead of time?  Yup.  Do they cost a lot.  More than ETFs and mutual funds but if you’re finding non-correlated returns, they should cost more.  The key question in today environment is what proportion of your portfolio do you want to allocate to market risk and how much to manager risk?

That one takes a bit of time to sink in once you really think about it.

Then you have to ask yourself, is it possible that regardless of which way I choose, it’s likely that the result will be very similar?  In other words, you put all your money in one of two possible portfolios:  All ETFs or all hedge funds … and the result is both go up or both go down!  Of course it’s possible that these portfolios go in opposite directions but that’s what we would expect and that’s why we assume the active-passive proportion decision is important.  But if they go the same way, then we’re likely to lose faith in what we were promised by someone.  The passive route promises very little.  The returns are what the markets provide.  It’s the active route that promises quite a bit more … sometime more than what was provided.  The real bummer is allocating significantly to private equity and hedge funds hoping that they will provide a buffer to the traditional core portfolio of more liquid positions but not reaching that result.  In other words over-promising and under-delivering.

Today’s deleveraged environment provides opportunities but an ever changing landscape for investors travelling the PE/HF path, some good and some bad. We hear of pension funds allocating more and more to many alternative asset classes and strategies.  I wonder if they are pleased or disappointed with their results.  Are the fees worth it?  Are managers providing alpha?  Is the illiquidity constraint more than they bargained for?  Were they too late in making asset mix shifts?  Have they improved their asset/liability situation?

Everyone is talking about credit problems (mortgage, auto, credit card) and the various tentacles of the US economy that are breaking down.  My sense is that it could be as dire as some are stating but the press is likely doing a decent job of sensationalizing the story.  But what about the pension landscape?  Low interest rates plus negative market returns of the past 12 months are bringing us back to the asset/liabiility mismatch situation we first saw during the market slide of 2000-2002.  Are these funds doing so well with their portfolio returns that the relatively low interest rate environment is not causing havoc to their books?  Is this yet another cause for concern for the US financial “infrastructure” landscape?  So many questions and I only wish I could provide simple yes or no answers.  Then asset allocation would be like ordering a pizza.

Despite the volatility we expect to find in international markets and especially in the so-called “developing and frontier markets” (I’m very much not liking those names anymore) there are so many reasons not to have anything but minimal exposure to the US whether it be equities, fixed income or dollars.  Fareed Zakaria’s commonly cited view that one must notice it’s not “the fall of the US” but “the rise of the rest” is important.  It’s important for investors because there’s a parallel to a shift in asset allocation that will surely happen … and it’s already started.  Just how much is an appropriate allocation to the emerging markets?  Defining what is or is not an emerging market or frontier market or even developed market would help in answering this.  But just as important, I believe that the simple move away from “home biased portfolios”, driven by an acknowledgment that intelligent/selective global diversification, is a necessary move in what is likely no longer a simple long-term up market.  Diversification may not be what it used to be, but along with compound interest, it’s one of the very few free lunches we investors have.

Put another way, imagine you are one of the sovereign wealth funds that the press and politicians seem to enjoy commenting on these days.  Recent allocations of these funds to western financial conglomerates (investment banks in need of capital and quickly) is a move to use some of their US dollars to buy relatively cheap assets that will provide some yield (surely negotiated to be better than what others are getting) as well as a buffer to their home grown commodity exposures.  I spend a lot of time thinking about what else is on their shopping list to diversify themselves away from existing commodity and US dollar related risks.  It’s the same exercise any investor should have with their portfolio and the positions held within it.

Today, I had a last minute invitation to speak on Canada’s Business News Network … that’s not a description, that’s its actual name. The channel was formerly known as “Report on Business Television” so you’ll have to decide if their name change was an improvement or not. The six and a half minute clip will be available for viewing online here until sometime late Monday evening of next week (when you click on this link I’ve provided, a small window with a built-in media player should pop open). If this doesn’t work, then go here and scroll down to the 4:40pm “After Hours” program. Hopefully, I will be able to have the clip viewed directly here on this blog at some point.

The opening shot of me appears to be my poker face or I’m about to enter the octagon for combat or it’s the once-a-month event when I screw up WordPress and lose a big chunk of my blog posting. Either way, it’s my “death stare” and I can only imagine that I felt pretty lousy running from my car to the building entrance of the studio in what has to be Toronto’s heaviest rain storm so far this year.

Anyway, the discussion was on market volatility but unfortunately the focus was almost entirely on VIX. I say “unfortunately” only because VIX can be (well, it is) a dry subject due to its rather technical nature. Despite being on the channel several times before, you’ll note that the topic of VIX was not quite enough to get me really loosened up until just a tiny bit near the end.

Well, here are two charts which I discuss during the interview:

3 Year VIX Chart

17.5 Year VIX Chart

I was hoping to get into a discussion on emerging markets, gold and oil markets, and a broader geopolitical debate. But at the end of the day, VIX is a tool worth considering for the defensively oriented investor so there’s merit in its discussion. Along with outright shorting and inverse ETFs, there’s not much out there in terms of true diversifiers/stabilizers available in this high correlation world.

On the other hand, I have actually noticed lately that a lot of hedge funds (fund-of-funds, multi-strategy funds and even some single strategy funds) have had better than decent performance in 2007 YTD. Could it be a result of the VIX spike up since late February? I’m sure it’s more than that but this good performance comes after a fairly long period of so-so returns.

On a separate note, after my interview, I had dinner with one of the ProShares directors who was up here in conjunction with Horizon BetaPro’s launch of their new Canadian energy sector index levered and inverse ETFs. This follows up BetaPro’s launch last week of similar long and short exposure ETFs for the Canadian financial sector.

Based on this BetaPro press release from April, it’s safe to say that we’ll be seeing the gold sector ETFs sometime soon as well.

For review, this is BetaPro’s lineup as of today:

Horizons BetaPro S&P/TSX 60 Bull Plus ETF - HXU
Horizons BetaPro S&P/TSX 60 Bear Plus ETF - HXD
Horizons BetaPro S&P/TSX Capped Financials Bull Plus ETF - HFU
Horizons BetaPro S&P/TSX Capped Financials Bear Plus ETF - HFD
Horizons BetaPro S&P/TSX Capped Energy Bull Plus ETF - HEU
Horizons BetaPro S&P/TSX Capped Energy Bear Plus ETF - HED

The Canadian ETF marketplace has basically doubled in a very short time especially due to the recent product development efforts at both BetaPro and Claymore. Unlike in the US, we don’t have as robust - some may say saturated - ETF marketplace here in Canada. Frankly, we don’t have the broad acceptance of ETFs here like there exists in the US so there is some balance there. I would guess by looking at reports, such as those from Deb Fuhr at Morgan Stanley, that all other markets outside of the US also have a rather small but growing ETF industry and that is likely where we’ll see significant growth as the ProShares, PowerShares, WisdomTree and other smaller participants do the same as BGI, SSGA and Vanguard with their already established global expansions.

I won’t get into the discussions I had with the gentleman from ProShares except for the fact that I asked the question that I think many want to have answered: When do we get the international exposures?

I’ll just leave you with a “let’s wait and see”. Let me be blunt as usual … I’d kind of like to see them, specifically inverse exposures for EAFE and emerging markets available before the end of the summer. Certainly before the end of the year.

Oh, and one last thing to consider for those of you who want to get some inverse exposure to emerging markets. I don’t know if that’s the right call (bearish on emerging markets) but considering the strong run up in China, central/eastern Europe and basically all subgroups in the developing world, it’s worth making preparations. But what to do when there’s no inverse ETF and shorting EEM or VWO is the only reasonable alternative? I suggested to my dinner partner from ProShares that the BetaPro S&P/TSX 60 Bear Plus Fund might be a good choice especially considering the relatively high correlation between the Canadian equity market (TSX 60) and a broad emerging market ETF like EEM. I would only guess that the new inverse energy sector ETF from BetaPro would be an even better proxy for a short EEM strategy. There’s not enough historical ETF data but your friendly neighborhood Bloomberg terminal, Thomson Datastream or similar data source should provide you with data for the underlying index as the evidence you need.

It’s a tough, high correlation world. But perhaps there are ways like this to use high correlations to your advantage. The problem is correlations change in time. I’d much rather have the inverse ETF.

With recent news of uranium futures contracts available through NYMEX beginning yesterday (May 7th), I was looking for a price chart for the spot price just to get my bearings on its rise which has been well publicized. It really is funny … go to Google, above the text box, choose “Images” and enter “Uranium price” for your search. You’ll get a LOT of uranium price charts all going from the bottom left to the top right. No surprise. But you’ll open one chart, say this one and you’ll think that the price is somewhere around 85.

The heading says that the data is up to February 2007, so your first guess is that this is a fairly up-to-date chart to start with. But then, through the same list of findings from your Google search, you also will find this chart:

Basically, this second chart only covers the rightmost section (roughly 1/5th) of the first graph. More importantly, this chart adds another couple of months which end up being significant as the uranium spot price has spiked even higher from around $85 to $113. That’s a 33% return in two months. That’s amazing but having this occur after a doubling of its price every calendar year for the past several years is actually quite scary. Kudos to anyone who jumped on uranium early (pre-2004) but a bigger and surely envious “congrats” to anyone who’s held on up till now.

From early April to early May, the price has remained quite flat around $113 and the second chart above (as with most short-term charts of uranium) shows that there are several instances where uranium prices will remain quite level for a period of weeks, if not months.

My point is that uranium has been rising (and rising and rising) over the past several years and to even have a 2-month old chart (geez, even a 2-week old chart in many instances) is playing with stale data.

Of all the news and commentary on this new futures contract, I found this article to be most insightful. It covers a lot of ground in a short read but similar to many of my posts, it goes into potential problems with this new derivative … just some things to think about before you dive in.

Also of note, NYMEX has teamed up with UX Consulting (provider of the 2nd chart above) on this derivative instrument and UX’s website is a great source of information for uranium in general as well as latest price charts … so you won’t have to go Googling for the latest chart.

With the way the ETF industry is moving, you’ve got to imagine that there are a lot of eyes on the launch of the uranium futures. The UPI article above discusses the issue of holding the underlying commodity. There are more than a few hurdles to deal with for an ETF launch for direct exposure to uranium prices. I’ve mentioned this in a few posts in the past but up here in Canada, the Toronto Stock Exchange lists Uranium Participation Corp (U) which might be the easiest way to gain exposure.

I titled this posting “Uranium Mania” simply because of the incredible parabolic curve of the price chart. The move to derivatives can, and likely will, help provide greater access to this market as would an ETF. I’m guessing that quite a few ETF manufacturers (and it’s not at all difficult to guess who they are) are watching developments with the new futures contracts and already have their business development people sniffing around to get a sense of demand for an ETF. News of an ETF would definitely bring us closer to a mania and it’s not difficult to forecast the final stages of the climb if this were to happen.

I’m thinking of an instrument (or instruments) that allow for upside and downside exposure to uranium prices that would best be accepted by the marketplace. Again, if you’ve been following this industry, a very short list of ETF developers come to mind.

But until then, for uranium plays it’s either:

1. Stock selection with big producers like Cameco and a small number of relatively large competitors but a large number of very small producers.

2. Uranium Participation Corp (and the added FX risk for non-Canadians)

3. Uranium futures with more information here

Good luck out there. Don’t get burned (sorry … bad one).

If there’s an area where commentary has exceeded that which is required, it has to be in the commodity complex. For every Jim Rogers on the bullish side there is more than likely an equally vocal counterpart on the other side. True to expectations, with such a hot sector, we have seen a decent share of commodity related ETFs, with certainly more than enough in the energy subsector. Broad based commodity index ETFs [PowerShares DB Commodity Index TrackingFund (DBC) and iShares GSCI Commodity-Indexed Trust (GSG)] have allowed for a one-stop shotgun approach but now Deutsche Bank (DB) and PowerShares have sliced and diced yet another sector (follow the Deutsche Bank link) but, to me, this development does deserve merit.

What investors now have is the ability to fine tune their required commodity allocation instead of letting DBC and GSG do it. The new funds are:

PowerShares DB Agriculture Fund (DBA)

PowerShares DB Base Metals Fund (DBB)

PowerShares DB Energy Fund (DBE)

PowerShares DB Oil Fund (DBO)

PowerShares DB Precious Metals Fund (DBP)

PowerShares DB Silver Fund (DBS)

PowerShares DB Gold Fund (DGL)

Is this slicing and dicing really required?

According to the factsheet for DBC on the DB Funds website, this is its breakdown:

35% light sweet crude

20% heating oil

12.5% aluminum

11.25% corn

11.25% wheat

10% gold

According to the iShares website, GSG, which tracks the GSCI Total Return Index, has a breakdown of:

71% energy

11% industrial metals

11% agriculture

5% livestock

2% precious metals

The DBC factsheet also gives some information that should be of no surprise to the commodity index investor. The performance table shows 1 year returns as of September 30, 2006 of 9.32% for the DB Commodity Index, -21.14% for the GSCI and -6.11% for the DJ-AIG Commodity Index. This type of wide discrepancy is commonly found when comparing various hedge fund indices but not your more traditional indices. The problem is in the composition. I would strongly suggest that investors in this space read this feature article from IndexUniverse.com written by Matt Hougan titled “Choose Your Commodity Index Wisely”. (The site requires membership which is free.) You’ll note that Matt’s article was written in May 2005 and the index breakdowns differ slightly from the data above but they’re not far off. Take special notice to the table at the end of his article that gives a nice comparison of the various indices and their breakdowns. Unfortunately, the DB Commodity Index was not one of the indices included in his analysis.

There’s not a lot of trading history, so here’s the six month chart showing DBC and GSG:

The general trends are similar but the gap is significant starting in early September when the lines diverge.

Bottom line is that there’s little surprise that the GSCI had by far the worst performance of the three cited commodity indices due to its roughly three-quarters exposure to energy.

Although I’m not as big an oil bull as I was one year or two years ago, longer term I’m still a bull. Recent news has suggested that the environment is as high a priority as any other to the average citizen. How will this play out in the energy/alternative energy space is a whole other blog entry. Whatever my call (or your call is), for sizeable portfolios and for sophisticated investors, DBC or GSG just can’t provide the precision required for adequate portfolio management. The commodity complex is just too broad a space to be managed with just a DBC or GSG position … aside for the very small sized portfolio.

Clearly, the new PowerShares ETFs overlap considerably with existing ETFs. Still, we’re seeing what I believe to be the first exposure into the agricultural space. The base metals ETF allows for exposure to aluminum, zinc and copper which have gained considerable online chatter over the past few years. The energy ETF is similar to USO and provides for a more diversified instrument compared to its counterpart, DBO.

To those that argue that the ETF market has, and continues to, “slice and dice” … I say their argument is strong for certain areas like the US equity market. In the case of the commodity complex, what Deutsche Bank and Powershares have brought to market is ideal.

This is really a follow up to Roger Nusbaum’s piece on the oil sands ETF. I mentioned this ETF, albeit briefly, here. I know: home field advantage as the Claymore guys here in Toronto are only a 5 minute drive away from my office.By the way, the weighting of underlying positions in this ETF is based on three factors:

1. Current production in barrels per day

2. Production expected in 2015

3. % of total production actually in Canadian oil sands

When I first heard of Claymore and the oil sands ETF, I thought they would have launched it by mid-late summer. I just spoke with the prez of Claymore Investments and he says this fund should be out by the end of October or first week of November. Oh that’s some good timing.

But here’s the point, or rather question, in this blog entry:

Personally, I still like oil and have not dumped our energy ETF positions although for private client accounts they are somewhere at around 4-8% of the overall portfolio. However, although I like oil, I’m not so sure about natural gas.

To me, one is a global commodity play that has some geopolitics as well as obvious emerging market stimulus. The other is a regional weather play. I won’t get into El Nino or the supply/demand imbalance for natural gas.

Bottom line: Long oil and short natural gas may be in play for roughly six months. Futures is easiest to implement, but I wonder is there a way to play natural gas in the ETF or CEF space?

Aside: I often write more on SeekingAlpha ETF topics rather than energy, so my apologies if this oil/gas discussion is a replay.

Back on June 12th I discussed PowerShares WilderHill Clean Energy ETF (PBW), and how it behaved relative to traditional energy exposures like iShares Goldman Sachs Natural Resource ETF (IGE), iShares S&P Global Energy Sector ETF (IXC), iShares Dow Jones US Energy Sector ETF (IYE), Vanguard Consumer Staples ETF (VDC) and Energy Select Sector SPDR ETF (XLE). I tried to make a case for buying PBW. The drop since then has proven me wrong, but I still think it’s an important holding, and my clients have held it throughout the year (we haven’t touched it), as it’s only about 3-5% of the total portfolio depending on the client.Well, it hit a low of around 16.50 on August 14th. It popped up about 10.5% thereafter, but had a 4% drop yesterday. This thing’s volatile.

As discussed on June 12th, what interests me about PBW is its correlation to the traditional energy ETFs. Take a look at this chart below comparing PBW and XLE over the past 12 months. I use XLE, but any of the other energy ETFs mentioned above could be used as well, since they are very similar in nature and performance. I care more about the trend when looking at these charts for this particular bit of analysis.

Note the relatively strong correlation prior to June 2006. The key difference prior to June 2006 was PBW’s stronger climb relative to XLE during the first half of 2006.

Again from my earlier piece, it’s important to note how important IT is in terms of PBW’s sector allocations. With a 30% IT weighting, it’s fairly significant. Energy has less than a 3% weighting in PBW. So why does PBW not have a chart more similar to the Nasdaq than to XLE?

There are some months with great similarity (November and December 2005), and they generally both decline, as did most markets this summer. But you don’t have the same strong similarity like you have between PBW and XLE prior to June 2006.

Although too simplistic in its discounting of underlying fundamentals for the component positions, PBW seems to be a vehicle traded as an energy proxy. The important question now is: What’s going on post June ‘06 that has lead to what seems like an “out of sync” relationship between PBW and XLE? Is it simply that traditional energy rose in July and August due to the war in Israel/Lebanon? That’s fairly obvious. But clearly we see a divergence after the first week of June 2006. This is the same chart as the first but only showing the past six months:

By eyeballing the lines closely, you see that the general weekly trends remain intact between the two ETFs in July and August. The only difference is the strong drive up by XLE in the latter half of June due to geopolitical concerns in the Middle East. But otherwise, we still see the same week-to-week trend matching.

PBW still seems to be an energy play, but acts as a more volatile proxy to oil producers. Sometimes we invest to diversify, sometimes it’s for the story, whether it’s macroeconomic or otherwise. PBW can be considered a “high volatility” energy play. I think similarly of Canada and emerging markets. Buying iShares MSCI Emerging Markets Index ETF (EEM) for a Canadian investor provides no diversification, but is more like having a levered position.

iShares MSCI Emerging Markets Indx ETF (EEM) vs. iShares MSCI Canada Index ETF (EWC) 2-yr Daily Chart

Lastly, I compare PBW and oil itself over the past three months, which is the period I initially commented as one of divergence. It seems more clear here:

Now for the first time we see true divergence, and very little week-to-week trend-matching. My feeling is that this is not the moment many have been waiting for. That is, the moment where alternative energy and traditional energy completely de-couple as oil drops down to $30 or less and the massive acceptance of alternative energy pushes something like PBW up astronomically. New oil find in the Gulf of not, I still think we’re many years away from that “paradigm shift.” But I still hold 3-5% in PowerShares WilderHill Clean Energy ETF (PBW) because it behaves like traditional energy, and you just never know. A 9/11 type plan except aimed at several mideast refineries could do it. I think the limited resources of what’s left of El-Qaeda would likely aim for a western target, perhaps American energy infrastructure.

Moving from speculation back to investing and focusing again on diversification (especially for Canadian investors with heavy energy exposure), I’m still waiting to find out more on the new PowerShares ETFs, specifically the PowerShares Cleantech Portfolio and the PowerShares WilderHill Progressive Energy Portfolio. I wonder how they will behave compared to PBW and other energy ETFs.

It’s interesting that a lot of innovation in the ETF space has come out of Canada. We’re like an incubator of ideas before the full rollout of products occurs in the US and globally. Below I discuss some new offerings to this market. They may prove to be clues of similar offerings that could soon appear in your jurisdiction.Up here in Canada, the ETF market is dominated by Barclays Global Investors. Recently BGI rebranded their ETF lineup from iUnits to iShares, similar to their ETF family in the US. DFA has had a presence here as well since 2003. TD Asset Management (a subsidiary of TD Bank) had a short attempt at the industry with a small family of ETFs. With a broad composite, as well as value and growth tilts on it, I thought these funds had a decent shot at building a following. It didn’t happen. My feeling is that the Canadian market is not that big, certainly not big enough to sustain too many ETFs. Still, as we’ve seen globally, ETF investing is gaining significant ground here.

Enter Claymore Investments (“Claymore”), a Canadian subsidiary of the Claymore Group out of Chicago. As I reported on June 20th, Claymore has teamed up with Rob Arnott’s Research Affiliates to bring fundamental indexation to Canada. Claymore now plans on launching 6 new ETFs in the following areas:

· Global Fundamental Indexation

· US Fundamental Indexation

· Japan Fundamental Indexation

· Oil Sands

· BRIC (Brazil Russia India China) and

· Dividend & Income

Like the Canadian Fundamental ETF, the new Claymore ETF FTSE RAFI products have a 65bps MER. The other 3 ETFs have a 60bps MER. Interestingly, Claymore has a 2nd class of ETF called “Advisor Class Units.” This tacks on 75bps as an annual service fee (in Canada, we call it a trailer fee) payable to the client’s advisor. A couple of thought on this fee structure. First, it allows Claymore’s offerings to have broader appeal, at least for those who are involved in selling financial products. Specific to Canada, I remember learning from DFA that their class of funds with similar trailer fees was a new company development tailored for the Canadian market. I believe that the Canadian marketplace is still behind the curve when product developers have to provide incentives to sell their products where such incentives are not required in other jurisdictions.

For global readers, I believe that the significance of the new fundamental weighted ETFs is further proof of the growth of non-market cap indexation. It’s too early to say whether or not fundamental indexation is a fad. Anything can happen, and like TD’s ETFs in Canada, any ETF without a large size of assets under management can quickly be shut down. However, I can only imagine that Rob Arnott as well as the guys from WisdomTree are making their rounds globally trying to spread their wares. The evidence is compelling: Moving away from cap weighted indexation, whether towards Arnott, Siegel or Fama/French, provides better risk-adjusted returns.

Now let’s focus on their last three ETFs. First, the oil sands. I don’t think this one is late to the market but my feeling is that every Canadian already has a position or ten in this sector. BGI Canada has an ETF that tracks the S&P/TSX Energy sub-sector (XEG), has a real track record of about five and a half years and with the usual oil sand majors well represented. Still, it’s true that there is no ETF specifically for the sector. The market will decide if one is needed.

Similarly, BGI has a dividend and income ETF even though it’s only about seven months old. It tracks the Dow Jones Canada Select Dividend Index. Although Claymore’s offering tracks a different underlying index (Mergent’s Canadian Dividend & Income Achievers Index), I’ll be eager to learn what are the overall yield targets and see how historical backtests compare in terms of volatility of returns. I would be surprised to see much difference between the two.

According to my contact at Claymore, this is the first BRIC ETF in the world. A lot of people have been waiting for this. Its planned launch is August 15th. It is based on the ADR’s that trade in the US, which limits liquidity concerns and local market issues. Also, the ADRs are only issued by companies that are regulated by the SEC. This is good in terms of dealing with companies that follow standardized accounting practices but clearly eliminates a lot of companies in these countries. Of interest only to Canadians is that the US$ currency from the ADRs will be hedged to eliminate the FX risk. Of interest to American and other investors is that a US domiciled version should be not too far behind.

The portfolio has roughly 70 holdings. Country breakdown is currently 50% Brazil, 30% China, 15% India, and 5% Russia. Since ETFs already exist for Brazil and China, I would be happier if larger allocations were given to India and Russia.

Industry Breakdown is:

Energy 29.33%

Telecommunication Services 16.28%

Financials 16.17%

Materials 14.91%

Information Technology 9.47%

Industrials 4.36%

Consumer Staples 4.15%

Utilities 3.35%

Consumer Discretionary 1.43%

Health Care 0.55%

My only concern with the BRIC ETF is the same I have with EEM. Another play on the commodity complex?! EEM’s chart looks a lot like that of an energy sector ETF. As time passes, I think I want to be dialing down, not up, on my overall commodity exposure. I’m still completely bullish on commodities, although maybe not like Jim Rogers, but I’m always thinking about how much of my portfolio is “commodity sensitive”, especially considering the flaw of “home bias” and thus how much our clients have in the Canadian market which is nearly 50% energy/materials. The dialing down of commodities may not be happening soon but I am simply cautious now of adding more.

What would really interest me is a product offering that combines the concept of BRIC investing with specific sectors that just make sense for these areas. For example, what about an infrastructure fund investing primarily in the BRIC countries? This would certainly be an actively managed fund so I”ll stop there.

As a professional manager, I’m happy to see the added fundamental weighted ETFs as potential core asset class positions. The BRIC ETF could be a nice add-on to the international equity lineup of EFA/EPP/EEM. However, with the still relatively young Canadian ETF industry, not in terms of years but in terms of assets and trading volumes, I will be somewhat cautious. With increased trading volumes I will become more comfortable in implementing these positions.

But what this industry really needs is greater acceptance of new entrants. This includes Claymore in Canada as well as WisdomTree, ProShares and Powershares in the US. Nothing against BGI, but maybe as an owner/operator of a small shop myself, I cheer for the small guy. BGI certainly has been an innovative provider in the past with new ETFs for more diverse asset classes but it’s the new small providers that have become the new innovators. Are they bringing too many products for the markets? Let the market decide. Some may become a BGI. Some may become a TD.

There are alot of energy based ETFs out there to select from, many of them covered well on Seeking Alpha’s ETF site. We have been holding all our energy related positions despite them being down roughly 12% from their peak in early May. Relatively high cash balances and some broad market put options have helped ease the pain. We still feel strongly about our long-term view on the commodity complex, especially energy, as well as certain other areas like emerging markets.For those that have built some cash, this is a follow up to my previous “shopping list” discussion but with a greater focus on energy. Now that we’re well into June, there will certainly be increasing talk of upcoming tropical storms and speculation of their potential growth to hurricane status. With ongoing events in Iraq and Iran, volatility in this area will certainly remain high which should be good for the numerous energy related funds I see popping up.

Below is a 1-year chart for five fairly broad energy related funds, although IGE tracks a broader natural resources index. I include it because according to the iShares website, it has a roughly 78% weight in oil/oil services plus 4% in gas. Not an insignificant divergence among these energy ETF choices, especially during the volatile period of the past three months.

Energy ETF 1-yr chart:

What interests me and what has been a great performer in our portfolios has been alternative energy, specifically the PowerShares WilderHill Clean Energy ETF (PBW). Taking the two “middle of the group” performers from the above chart and including PBW, we have the following 1-year chart:

PBW 1-yr chart:

I note two things from this second chart:

1. There is a fairly high correlation between all the funds which is of little surprise.

2. PBW’s relative outperformance of other broad energy ETFs.

With regard to the correlation, we can see from this chart that from early June 2005 to early January 2006, the lines overlap fairly well. The only sizeable divergence was during late August/early September (prime hurricane season).

But what about the sizeable divergence for most of 2006? The stocks shown above have similar up and down blips, but PBW seems to have become a “high beta” version of the energy plays. Proof is in the recent declines. PBW is down nearly 18% since its peak on May 9th. VDE and XLE’s declines are 13% and 12% respectively.

This really isn’t that surprising if you go to the PowerShares website and look at the holdings of PBW. The roughly 40 positions are certainly not all big names. Big sector weights in info tech (30%) and industrials (35%). Energy is shown as having only a 2.4% weighting. Average market cap of PBW is somewhere between that of PowerShares’ small and mid-cap ETFs. So the volatility is not that surprising.

Analysis of the 4 largest holdings (IMCO, QTWW, MGPI, ZOLT) as well as the largest positions thereafter show a general common uptrend from the beginning of the year. All of these positions have a story that is quite separate from the broad energy story. Thus, it might seem that during times of higher energy focus in the financial markets (like hurricane season), PBW behaves more like an energy fund as investors play the alternative angle. At other times, the fundamentals of its underlying holdings play a more distinctive and significant role.

If this hurricane season is anything even close to last year, you really have to wonder if alternative energy will be perceived as a place for significant asset allocation. I’m still not sold on alternative energy’s potential to replace traditional energy to keep the manufacturing process moving. I just can’t imagine how alternative energy could even come close to addressing global energy needs all if oil, coal and nuclear were suddenly wiped off the planet today. We’ve got a long way to go which is all the more reason to see the potential upside on something like PBW.

Finally, I was recently at an environmental finance conference sponsored by the University of Toronto. The main subject of the conference was actually “cleantech.” Interesting that there was a big absence of investors (institutional or retail) at the event. Through a contact from the event, I learned of a potential cleantech ETF. This was confirmed Wednesday of last week with the new of PowerShares’ SEC filing of 31 (wow!) new ETFs including the PowerShares Cleantech Portfolio ETF. Something to watch for.

Again, what we’re looking for here is something that can behave like an energy play during energy sensitive periods (with price action on the upside) and with potential greater upside during times of less dramatic energy sensitivity in the markets and general public persona.

Just remember that PBW is volatile. The current 18% drop is not the first time this has happened in PBW’s short 15 and a half month life. It had about the exact same percentage drop in its first two months (March/April 2005) and again in the fall of 2005 (basically after Katrina). Strong stomach required.

PBW 1-yr chart:

Whether you believe that the correction is nearly over, or that we’re about halfway through (or even more bearish than that), hopefully you have built some cash reserves and hopefully this was done prior to the May selloff. If so, it’s time to build a shopping list. Here are some positions to consider:1) First, a look at an area that has been hurt badly and is probably the best area for constructive debate: emerging markets. The iShares emerging market ETF (EEM) has gone from a high of about 111.25 to 89.80 (always using yesterday’s close), down about 19.1%. Vanguard Emerging Markets VIPERs (VWO) has gone from a high of about 76.51 to 61.63, down about 19.4%.

Coincidentally, according to the charts, we’re right back where we were at the beginning of 2006. Roughly 0% return YTD. Now, there’s been a lot of talk about potential slowing of trade in the EM region as a consequence to bearish views on the US economy and rightly so, but what percentage of future EM trade will be dependent on North America? Separately, looking at a long-term chart of EEM/VWO, you have to think that some steam had to be released from the pressure cooker.

Also important to note are the big holdings in EEM/VWO like Samsung Electronics. It is the largest holding in both of these ETFs with roughly 5% weighting in each. That’s actually not bad compared to Samsung’s roughly 20% weight in the South Korean ETF (EWY). South Korea is down just over 16% since its peak in early May and so it isn’t surprising that EEM/VWO are both down similar amounts considering that there are some large holdings from this one country (Of note, South Korea raised rates unexpectedly today which could further the bleeding … in fact South Korea was down 3.5% Thursday with the rest of east Asia performing similarly).

Of course, there are significant holdings in other EM regions like Latin America which have been even worse. The Latin America ETF (ILF) is down about 22.6% since its peak on May 10th. Again coincidentally, ILF is very close to where it was at the beginning of the year. The numbers may sound scary, but I think there’s plenty of room for prices to go down further. How far and for how long no one can know. I haven’t even commented on views regarding the BRIC countries and news of possible upcoming BRIC ETFs. But as a long-term investor, I think it would be prudent to at least have a 5-10% allocation to EM equities such as EEM or VWO. The trick will be avoiding major drawdowns like we’ve seen in the past month.

2. Bond ETFs. Inflation and the debate if there is or isn’t any, or if there will be or won’t be any in the near future has almost made my mind numb on the subject. It seems like it’s an unending debate on CNBC but luckily the World Cup will occupy a lot of my upcoming screen time. We’re still not fully in on our bond exposures (relatively overweight cash in lieu of bond ETFs). We’ve held certain index bond mutual funds and a few bond ETFs (including TIP) but are currently working on this area of the shopping list. I’d like to see a US domiciled international bond ETF. Let me know if there is one. For now, I’m watching TLT. I’ll update our progress on this area in a later entry.

3. Commodities. We’ve held all our commodity based ETFs during this market downturn as we have only about a 5% weight in materials (gold related ETFs) and energy (IGE, PBW). Of note to Canadian investors, we hold the TSX gold subindex ETF [XGD] and the TSX energy subindex ETF [XEG], both traded on the TSX.

We may rebalance these by topping up at some point but expect both gold and oil related ETFs do drive up sharply over the summer months. For those that have been tactically inclined and gotten out of these positions recently, I can only bet that you are contemplating new points of entry. But, like the EM positions from point #1, these are obviously volatile so from a risk budgeting framework, I would not consider putting more than 10-15% in the commodity complex.

We, up here in Canada, are not immune to the “home bias” phenomenon so have greater than global market cap weighted allocation to Canadian equities. Thus, since a broad Canadian ETF has nearly 50% allocation to materials/energy, an investor with a 10-15% allocation to the commodity complex plus a 20% allocation to Canadian equities may actually have close to a 25% commodity sensitive portfolio.

Thursday’s opening bell is about to go off. Despite some news from Iraq, the mood is not good at all after market action from Europe and Asia. A lot of uncertainty. Wouldn’t be surprised if VIX finally breaks above 20.