Five Good ETF Ideas That Haven’t Caught On (Yet)

August 28, 2008

We all love to make fun of the zany ETFs that come to market and never attract any assets.

You know, like the HealthShares Ophthalmology ETF (NYSEArca: HHZ). The idea that $200 million in assets would flow into ophthalmology companies was prima facie absurd, something the fund's developer—XShares—has now recognized, as the fund is being liquidated on September 19.

But for every ophthalmology ETF, there is an ETF backed by a good idea that never catches on. I might count the HealthShares Cancer ETF (NYSEArca: HHK) among them. Cancer is a legitimate subclass of the healthcare industry; an area where tons of new money and legitimate scientific breakthroughs are changing the way we treat a disease. I'm not making allocations to cancer in my portfolio, but I wouldn't fault somebody who did.

With that in mind, I thought I'd look at the list of ETFs with very little assets to see what gems lie beneath the rubble. To make it fun, I thought I'd highlight only funds with less than $10 million in assets as of July 31, 2008. In some cases, the funds have just launched and haven't had enough time to attract assets; in other cases, they've languished on the market for years.

This is not a recommendation to buy any of these funds, which have some flaws and don't belong in every portfolio. But it is a reminder that there are some interesting funds out there that people pass up.

Good Funds With Less Than $10 Million In Assets

1) United States 12 Month Oil (AMEX: USL): People love to invest in oil using ETFs. The United States Oil Fund (AMEX: USO) has over $1 billion in assets, and has become the retail trading vehicle for crude.

The United States 12 Month Oil Fund, however, has attracted just $7 million since launching late last year. That's odd, as you could argue that USL is a better proxy for the oil market than USO.

The difference is this: USO follows the "classic" method of investing in the oil space. It buys the near-month crude oil futures contract and then rolls that position over month-to-month. For example, right now, USO holds oil contracts expiring in October; before those contracts expire, it will buy oil contracts expiring in November. And so on and so on.

By contrast, USO spreads its oil contracts out over 12 months: It owns a few October contracts, a few November contracts, a few December contracts, etc., right up through September of next year.

Why should you care? Because often, there's a big gap between the near-month oil contract and the second-month oil contract. This can either boost returns, if the near-month price is lower than the second-month (a situation called backwardation), or cut into returns if the near-month price is higher (a situation called contango). The impact can be large: In 2006, oil investors regularly lost 2-3% of their returns each month because the market was in contango.

In theory, USL should stick closer to the spot price of oil than USO over time.

So why hasn't it caught on? For one, it's complicated to understand the differences, and with USO coming first to market, it had a huge advantage. Moreover, right now the market is in backwardation, which means that USO should outperform USL in the short term. But things have been moving around quickly in the oil space, and just a few months ago, the opposite was true. I think over time investors may come to see the wisdom of moving back and forth between USL and USO depending on the status of the oil markets.


2) iPath Global Carbon ETN (NYSEArca: GRN)

The iPath Global Carbon Credit ETN (NYSEArca: GRN) is the only product I know of that lets you easily invest in the value of carbon credits.  The fund has performed terribly since it launched, falling 26% in July, which probably explains the low asset counts. But the idea of tapping into this fast-growing market still strikes me as appealing.

The problem, I suppose, is that few people know how or where GRN would fit into a portfolio. Roger Nusbaum of has expressed surprise that the historical correlation between carbon credits and stocks is high, but that makes perfect sense to me: The value of carbon credits will increase as industrial production increases, and decline as industrial production declines, just like stocks.

Given its dismal performance since launching in early July, I'm not really surprised GRN has no assets. But I suspect that, over time, as investors come to understand this market, funds and notes like GRN will find a home.


3) Market Vectors - Gulf States (NYSEArca: MES)

We've seen two ETFs launch in the past year focused on the Middle East & Africa: the PowerShares MENA ETF (NASDAQGM: PMNA) and the Market Vectors Gulf States Index (NYSEArca: MES). Both launched in July 2008, so they haven't had much time to gather assets: As of 8/27, PMNA had $31 million and MES had just $4 million.

I chose to focus on MES because of its smaller asset count and also because of its pure-play focus on the Middle East. At a time when the correlation between U.S. and international stocks is narrowing quickly, the Middle East offers a solid opportunity for diversification. If you think high oil prices are hurting the global economy, for instance, you've got to imagine that they're helping the Middle East.

Don't just take my word for it, either: For the year ending July 31, 2008, the index for MES was up 21.8%, while the S&P 500 was down 11.1%. Now that's diversification.


4) Claymore/Alpha China SmallCap (AMEX: HAO): Speaking of diversification, is anyone else surprised that the Claymore/AlphaShares China Small Cap Index ETF (AMEX: HAO) has attracted so few assets? As of July 31, it had just $9.8 million in assets according to Morningstar, although that's since jumped to $21 million as of August 27 (perhaps a post-Olympics boom?).

The case for this ETF seems clear. China is growing fast. The big, state-owned companies like PetroChina and the Bank of China are pseudo-government entities that don't reflect the innovation in that society. If you really believe in a rising China with a rising, creative middle class, you've got to believe in the entrepreneurial power of the Chinese citizens. Investing in small-caps gives you access to this power, and HAO is the only way to do it.

I know, I know—the fund has gone nowhere but down since launching in late-2007, and is off more than 25% this year. But still, it strikes me as an interesting idea.


5) NYSE Arca Tech 100 (NYSEArca: NXT): This is one of my favorite stories because it shows just how odd the market can be. The Nasdaq-100 is a very odd index. It holds only stocks listed on the Nasdaq; it has a top-heavy weighting system that, right now, puts a 13.5% allocation toward Apple; and it's widely regarded as a "tech" index despite the fact that only 65% of the index is invested in Technology.

The NYSE Arca Tech 100, by contrast, makes a great deal more sense while being structured in a similar way to the Nasdaq-100. The NYSE Arca Tech 100 tracks companies listed on all three U.S. exchanges, rather than artificially restricting itself to one; it puts a 5% maximum cap on weighting any component, to keep from being top-heavy (although it unfortunately uses a price-weighting mechanism, as opposed to a market-cap-weighting approach); and it is, as the name suggests, an index of 100 leading technology companies, with none of the Financial or other exposure that clogs up the Nasdaq-100.

And yet, NXT has $7 million in assets and PowerShares Nasdaq-100 ETF (NASDAQGM: QQQQ) ETF has $17 billion. Go figure.

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