5 Most-Needed Niche ETFs

From sub-Saharan Africa to Eastern Europe, untapped markets still exist.

In a world of 1,575 ETFs, issuers are increasingly forced to stretch their imaginations to roll out something new and different.

I’ve got to admit that these days, more often than not, I’m rolling my eyes at most ETF filings.

That’s expected. Most investable markets have already been tapped into, and finding an untapped niche market is now akin to finding a needle in a haystack.

That said, every once in a while, a new ETF makes me wonder why it wasn’t launched earlier. I’ll admit I’ve also been proven wrong about a few new ETFs that I thought were going nowhere but ended up raking in big assets.

I’m going to point out five niche markets that haven’t been tapped yet by an ETF that I think have big potential if an issuer were able to launch such a fund.

Here are my top picks, along with explanations on their need. I’ve also included the closest available ETFs and what’s brewing in the pipeline in each space.

1) Sub-Saharan Africa ex-South Africa ETF

This one’s a no-brainer to me, and I’m pretty confident we’ll see a launch in this space in the coming year or two. Many smaller African nations have been growing at impressive clips due to their vast natural resources, cheap labor and renewed political stability.

As labor costs rise in China, multinationals are beginning to look elsewhere. South East Asia and Africa have been beneficiaries on that front, as Stratfor’s George Friedman recently pointed out in our Alpha Think Tank publication. News of Unilever’s plans to open a manufacturing plant in Ethiopia is only the latest, but not the last, plan we’ll hear about on that front.

Early in the year, Matt Hougan, president of ETF.com, highlighted the Market Vectors Africa ETF (AFK | D-28), as one of his top three picks for 2014, while voicing his concerns about AFK’s heavy weighting to South Africa, an emerging market.

It’s important to separate emerging South Africa from frontier Africa. In terms of economic prowess, South Africa is in its own league on the continent. It’s now often included with the BRIC economies, becoming the fifth wheel under the new acronym, “BRICS.” That’s why South Africa overwhelmingly dominates any ETF targeting Africa.

If you strip out South Africa, Egypt and Morocco, this new sub-Saharan Africa ETF would provide broad, diversified exposure to “frontier” African economies like Nigeria, Kenya, Mauritius, Botswana, Ivory Coast and Ghana.

• Closest available option:

1. AFK
2. Global X Nigeria ETF (NGE | F-53)

• In the pipeline:

1. iShares MSCI EFM Africa ex-South Africa ETF
2. Global X sub-Saharan Africa ETF

2) Eastern Europe ex-Russia ETF

Ruchir Sharma, head of Emerging Markets at Morgan Stanley and author of Breakout Nations, often talks about Czech Republic and Poland being in the “sweet spot” of Europe. After, all, they’re now European Union members, but haven’t yet adopted the euro.

George Friedman also told ETF.com that he favors Eastern European nations that aren’t “saddled by the euro.” On that front, with the exception of Slovakia, Estonia, Latvia and Slovenia, none of the larger Eastern European nations are yet part of the eurozone.

The problem with current offerings like the iShares MSCI Emerging Markets Eastern Europe ETF (ESR | C-71) is that Russia utterly dominates the market capitalization of these funds. ESR, for example, has close to 70 percent in Russia—so you might as well buy a Russia ETF.

Strip Russia out of the mix, and you get a more level playing field, with exposure to countries like Croatia, Czech Republic, Estonia, Hungary, Lithuania, Poland, Romania, Slovakia, Slovenia and Ukraine (Turkey, by the way, is a wild card, because it’s debated as to which region it belongs in).

While all these countries won’t initially make the cut in any number of ETFs due to size or liquidity requirements, that will change. As Eastern Europe grows, we’ll likely see securities from smaller, less-developed countries make the list.

• Closest available options:

1. ESR
2. SPDR S&P Emerging Europe ETF (GUR | D-87)

• In the pipeline:

1. Global X Eastern Europe ETF
2. Market Vectors Emerging Markets Europe ETF

3) Japan Sector ETFs

I’m still surprised there’s currently no Japan sector ETFs, which I alluded to in a recent blog. By now, I’m sure most investors are aware that Abenomics, the economic revival program championed by Japanese Prime Minister Shinzo Abe, isn’t bullet proof.

If Abe’s structural reforms fall short and the Japanese economy starts to falter, it’s very possible the Bank of Japan will increase its stimulus program. That would mean more yen flooding into the global markets, thus leading to more yen weakness.

For Abenomics 2.0, being tactical should be an option.

If the yen continues its depreciation and inflation picks up, real estate is a likely winner here. Financials can also be potential winners if the Japanese start investing in their own stock market through the newly launched, tax-free Nippon Individual Savings Account program.

Currently, WisdomTree has several Japan sector ETFs in filing, which I wouldn’t be surprised to see launch in the near future.

• Closest available options:

1. None

• In the pipeline:

1. WisdomTree Japan Hedged Real Estate Fund
2. WisdomTree Japan Hedged Financials Fund
3. WisdomTree Capital Goods Fund
4. WisdomTree Japan Hedged Health Care Fund
5. WisdomTree Japan Hedged Tech, Media and Telecom Fund

4) Frontier Asia ETF

Matt Hougan recently blogged about this, but frontier markets aren’t equal on many fronts. In some respect, they are a hodgepodge of countries outside the developed or emerging classifications, causing frontier indexes to be quite lopsided—the iShares MSCI Frontier 100 ETF (FM | D-94) has almost 60 percent allocated to the Gulf States of Kuwait, Qatar and UAE.

Regional frontier markets exposure makes sense. As mentioned earlier, as labor costs rise in China, multinationals are relocating plants to South East Asian nations. Vietnam, in particular, has benefited from this rotation.

The old Asian Tiger economies of Hong Kong, Indonesia, Malaysia, Singapore, South Korea, Taiwan and Thailand may be replaced by the new Asian Tigers of the coming decade, like Bangladesh, Pakistan, Sri Lanka and Vietnam.

Cambodia and Laos still only have a handful of listed companies between the two, and Myanmar—highly sought after by global investors—doesn’t have a stock exchange yet, though it’s currently in the works.

Again, investability is the key here. Even if an issuer wants to create such a fund, liquidity and accessibility issues are likely to be a roadblock. But as these economies grow and mature, this would be a region that I’d be interested in.

• Closest available options:

1. Market Vectors Vietnam (VNM | C-36)

• In the pipeline:

1. None

5) China Environmental Strategies ETF

The idea of a China-focused environmental fund may not be a “badly needed” niche play but, before you roll your eyes, hear me out.

Pollution in China has reached epic proportions. It’s no longer simply a public menace, but a matter of life and death, at least in some areas of China.

I still remember standing in Tiananmen’s Square not too long ago, barely able to see Mao Zedong’s picture hanging above the entrance to the Forbidden City as I gazed that way from across the street. We often get poor visibility here in San Francisco, but there’s a huge difference between fog and smog!

The new Chinese regime made it clear in the Third Plenary session that cleaning up the environment is a priority. This also extends to tackling the country’s ongoing water crisis.

The government is expected to pour billions of dollars into cleaning up the environment in the coming years, likely benefiting companies in that space. Jim Rogers alluded to this point in a recent interview for our Alpha Think Tank.

Being tactical makes sense in China, rather than continuing to pile into the same state-owned enterprises in the energy, telecom and financial space.

An ETF consisting of companies involved in cleaning up the environment, including clean energy and water companies, looks like a promising way to invest in China’s future.

• Closest available options:

1. KraneShares Five Year Plan ETF (KFYP)

• In the pipeline:

1. None

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