Exciting ETFs
By Chandler Lutz
February 9, 2008
Exchange Traded Funds (ETFs) grow in size and number almost continuously. There are more ETFs today than ever before and these newer investment vehicles present an interesting alternative to traditional equities or mutual funds. There is an ETF for every sector, industry region and idea you can think of. I’m sure if you search hard enough you could probably find an ETF with holdings in only firms from North Dakota that start with the letter Q.
If you are new to ETFs, or if you want to brush up on your skills, you can check out Yahoo’s ETF center.
Many investors prefer ETFs since they offer wide diversification and low expense ratios compared to mutual funds. Also, ETFs can allow investors to take advantage of a broad macroeconomic dynamic that can play out over a long period of time. If you identify such a dynamic an even better strategy may be to use the ETF as a starting point for future research. After all, who wants to own the losers that the ETF will eventually pick up? In today’s article we’ll look at a few interesting ETFs from PowerShares.
The first ETF we will study is PowerShares BuyBack Achievers Portfolio (PKW). This fund tracks the Share Buyback Achievers Index. To be a member of this fund a firm must have bought back at least 5 percent of their shares over the last twelve months. With the ubiquitous use of stock options in corporate America is not as powerful as it would have been 20 years ago, but many investors believe that buying back shares still represents a positive signal. The one thing that I really don’t like about the fund (from the standpoint of a potential investment) is that the fund is reconstituted annually and companies that repurchase their shares often see great returns in the following 4 years (see Ikenberry et al) after the repurchase and 45 percent positive abnormal returns if the repurchase program is due to undervaluation. Right now, I do not think that this fund is a worthwhile investment for my own portfolio for how it's constructed. Also, the fund is down 12.9 percent over the last year while the S&P is down only 7.33 percent. To some investors this may be quite alarming, but this performance is what is to be expected. In a down market, firms often times repurchase shares as valuations become depressed. Over the short term, these firms may suffer from further market turmoil, but if the managers are correct about the valuation of the firm shareholders will reap the rewards well into the future. This hypothesis may be evinced by the fact during the last recession the index that the ETF tracks (the index wasn’t created until recently) underperformed the S&P 500, but beat the traditional index by substantial margins as the market recovered and the bull market ensued. For me personally, I am not considering the fund as investment, but I think it’s a great place for starting future research. For example, one of the fund’s largest holdings is Disney. The market has punished the firm due to fears of recession and slowing consumer discretionary research. The company dropped from 35 dollars a share a year ago all the way down to 28 before rebounding to the 32 dollar range. In fiscal year 2007, the company repurchased 200 million shares for 6.9 billion dollars. Also, between August of 2004 and the end of FY 2007 the media conglomerate repurchased 16 billion dollars worth of stock which accounted for 550 million shares. Given Disney’s past track record of share repurchases, it is likely that the company will continue such measures at as long as the firm’s valuations remain attractive.
Another appealing index fund by PowerShares is the Global Water Portfolio (PIO). This fund tracks the Palisades Global Water Index. Water is a dynamic with explosive potential. As the world industrializes and countries continue to develop people will demand cleaner and safer water. PowerShares also has another water resources index fund (PHO), but I chose to highlight the global fund in this article because I believe that international firms will be able to capitalize on the global aspect of this dynamic. The Global Water Portfolio is internationally diversified with just 27.79 percent of the firms located inside the United States.
Over the last three years the Global Water Portfolio has returned 24 percent while the S&P 500 has returned just 11 percent. Many investors may believe that the water supply-demand relationship is quite obvious and the index will trade at pricier valuations. However, the average stock price to earnings ratio for the fund is 16.13 compared to more than 20 for the S&P 500. Also, the price to book is a reasonable 2.77.
The return on equity for this fund, 15.89, is lower than that of the S&P 500, 20.9. For investors looking for international diversification and the opportunity to beat market over the next several years this fund might be worth a look.
The last ETF we will study is the PowerShares Dividend Achievers Portfolio (PFM). This fund tracks the Broad Dividend Achievers Index. The index includes firms that have increased their dividend every year for the last ten years. This fund includes stable firms that investors flock to in hard times such as Exxon-Mobil, GE, Johnson & Johnson, and Wal-Mart. Over the last ten years this index has returned 6.60 percent a year compared to the S&P 500 which has returned 5.91 percent a year. These numbers don’t seem impressive, but they don't include reinvested dividends and the Dividend Achievers Portfolio currently has yield of 2.03 percent. If you are looking for a dividend stock, you want to make sure that the dividend is stable and the holdings of this fund are a great place to start the search.
Exchange traded funds can provide investors with attractive investments, but they can also provide investors with a great place to start searching for individual equities with potential to beat the market over the term.
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