3 Unloved ETFs With Big Potential

May 20, 2014

ETF themes and underlying assets that fall out of favor can offer attractive upsides.

It’s tough finding bargains in today’s market, where the Dow is brushing up against new highs practically every day.

Occasionally, many of us like to trade on momentum, but the investor side of me is constantly looking for opportunities in niche ETFs that are largely ignored, or even hated, at the moment.

Of course, trying to pick a bottom in any hated market is a fool’s errand, and can lose you a lot of money. But that’s also why you never go “all-in” and bet the farm on a quick turnaround, either.

Matt Hougan recently pointed out 10 “forgotten” ETFs that he likes. Here are three additional “under-loved” ETFs that are on my radar.

Note: I’ve singled out these funds based solely on their exposure to the underlying asset or theme, not based on costs or liquidity. I’m not necessarily bullish on these themes—I simply see potential in them if market consensus is wrong and there’s a surprise change in their underlying fundamentals.

WisdomTree Japan Interest Rate Strategy (JGBB)

AUM: $5M

Expense Ratio: 0.50 percent

JGBB has been on my radar since it launched last December. Many analysts think it’s only a matter of time before the Bank of Japan (BoJ) is forced to unleash more stimuli to keep Abenomics on course, which is losing steam of late.

When the BoJ initially shocked and awed with its massive stimulus plan in April 2013, 10-year Japanese government bond (JGB) yields plunged to a record-low 31.5 bps, only to immediately skyrocket to 100 bps about a month later.

There’s a case to be made that the better way to play Abenomics is to capitalize on the unintended consequences of Abe’s and the BoJ’s policies over the long run.

An obvious consequence—if you want to call it that—has been the plunging yen. The other consequence could very well manifest itself in the JGB market if inflation picks up.

JGBB is precisely a bet on those two major themes: rising JGB yields; and a falling yen.

The fund shorts five- to 10-year JGB futures, while taking on an equal notional “long” position in ultra-short Treasury bills with maturities of less than three months. Per WisdomTree, JGBB had a negative duration of -6.87 as of March 31, 2014.

From a currency perspective, JGBB carries a net notional short position in the Japanese yen against the US dollar. It targets roughly a 30 percent notional yen short, though that short exposure is currently about 24 percent.

Even the BoJ is perplexed by 10-year JGBs, which are now yielding 59 bps. That’s the lowest in the world, even though core inflation in Japan clocked in at 1.3 percent in March. Something feels amiss here.

Perhaps the market isn’t buying that inflation number. Or perhaps the market is expecting more bond buying down the line (similar to the way yields are plummeting in Europe in anticipation of some form of QE from the ECB).

JGBB likely won’t be a “home run” play. While some catastrophic event in the JGB market is a possibility, as the BoJ has stated, we’re more likely to see a gradual rise in rates.

Caveat emptor: JGBB barely trades at the moment, so careful monitoring of NAV and spreads is essential. JGBB charges 50 bps, but shorting bonds comes with embedded negative yields, so the true holding costs of JGBB will likely run more than 80 bps.

For investors concerned about liquidity, there are two other established inverse JGB ETNs that short 10-year JGB futures. The PowerShares DB Inverse Japanese Govt Bond Futures ETN (JGBS) trades more than $150K on most days, while the PowerShares DB 3X Inverse Govt Bond Futures ETN (JGBD) has a median daily volume of $400K.

10 Year JGB Yields

USD-JPY 5 Years

 

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