3 Unloved ETFs With Big Potential

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.

Global X Uranium (URA | C-93)

AUM: $217M

Expense Ratio: 0.69 percent

Only a few years ago, folks were calling for a renewed nuclear energy revolution.

In today’s post-Fukushima nuclear disaster world, everyone hates nuclear energy, including me. Uranium prices have plunged, and with it, uranium miners. For example, URA is down close to 18 percent in just the past year (it’s down more than 75 percent since its peak in February 2011).

Still, sentiment is so negative at the moment that from an investment perspective, it’s starting to look interesting to me.

Looking to Japan again, the country is facing a dilemma. Abenomics is losing steam, but policymakers in Japan seem to be fully committed to the “recovery.” Even if the BoJ wants to step in to save the day, imported energy costs are rising, adding to inflationary pressures.

If push comes to shove, I wouldn’t be surprised if Japan is forced to restart its reactors, which have been shut down since the disaster—not because they want to, but because they have to.

Interestingly, with the Nikkei dropping and inflation ticking up, Abe recently announced that Japan will no longer phase out nuclear. Coincidence?

URA is currently the only “pure-play” ETF on uranium miners. The cap-weighted fund provides exposure to 23 of the largest global uranium miners (which include a barrage of small- and micro-caps).

While its 69 bp price tag isn’t cheap, URA more than makes up for that cost with its stellar tracking—URA beat its index on a rolling 12-month median basis over the past two years (likely from securities-lending revenue from its micro-cap holdings).

In some respects, URA reminds me of clean energy ETFs left for dead only 18 months ago. We all know the unexpected happened since—they’ve been some of the top-performing ETFs since then.

While certain companies may very well go bust, I doubt nuclear energy is totally dead. It will likely remain an important part of the world’s energy mix in the future.

As much as people hate nuclear, when it operates properly, it emits zero greenhouse gases. China is dealing with an epic pollution problem, and it’s unlikely China will take its foot off the pedal around nuclear energy.

It goes without saying that URA is a highly speculative, niche-y play. Trying to pick the bottom for a quick and easy swing trade could prove disastrous.

I’m not a uranium expert, nor am I bullish on uranium. I’m merely pointing out one of the most hated themes at the moment, and often times, opportunities present themselves when the future looks so bleak for a specific market.

EGShares Beyond BRICs (BBRC | D-39)

AUM: $171M

Expense Ratio: 0.58 percent

I think the broad rotation from emerging markets (EM) to developed markets might be overdone here. The MSCI Emerging Markets IMI Index is now trading at a trailing P/E of 12.95, compared with 20.27 for the MSCI USA IMI Index and 19.27 for the MSCI World Ex-USA IMI Index.

I’m not the biggest fan of broad EM ETFs. I think the BRICs have matured and EMs will likely perform differently from each other in the coming decade, compared with what we saw last decade.

That said, sitting at a desk in San Francisco, I’m not going to pretend to be an expert in each and every single emerging country. But if I’m going to go somewhat broad, I prefer to strip out the BRICs. That’s where BBRC comes in.

BBRC strips out the BRICs, plus Taiwan and S. Korea, focusing on smaller emerging markets. It goes even further down the development chain, saving 25 percent of its weighting for frontier markets.

The cap-weighted BBRC selects the largest 75 companies from “beyond BRICs” EMs, and the 15 most liquid companies from frontier markets. In essence, it’s a smaller emerging/larger frontier markets ETF.

BBRC’s change to a FTSE index last October is really paying off. The fund has grown more than sevenfold, from $22 million at the start of 2014 to $171 million today. Liquidity has really picked up as well, now trading at more than $350,000 on most days.

Since the index change in late October, BBRC has also held up better than some of the most popular broad EM funds (see chart below).

Here at ETF.com, we see BBRC as a legitimate and new take on EM investing. With BBRC’s improved liquidity and stability, we’ve added the fund to our “Opportunities List.”

If I’m going to play a turnaround in emerging markets, especially some of the “fragile five” like South Africa, Indonesia and Turkey, BBRC is my favorite EM ETF.

All charts: Bloomberg

At the time this article was written, the author held a long position in BBRC. Contact Dennis Hudachek at [email protected], or follow him on Twitter @Dennis_Hudachek.