BRIC ETFs and ETFs vs Mutual Funds

Today I am going to reply to Blondie’s comments (December 12, 2009 blog) about investing in ETFs (Exchange Traded Funds), Asia ETFs (not including Japan) and BRIC (Brazil, Russia, India and China) index ETFs. Let’s start with the advantages and disadvantages of investing in ETFs vs. mutual funds:

Advantages

1. Tax efficient. You get to decide when it makes sense tax-wise to sell the ETF. Mutual funds by law have to distribute short and long tax gains every year (the fund could lose money for the year and still distribute tax gains).

2. ETFs have much lower fees than mutual funds (you do have to pay the cost of buying the ETF shares just like buying shares of Apple (AAPL). You can use a low cost broker (i.e. ETRADE) to keep the cost down).

3. ETFs are like stocks: you can sell them at any time, you can use “limit” and “stop” orders and can buy on margin and do options on the ETF within a brokerage account.

4. ETFs are very easy to buy. All you need is a brokerage account.

Disadvantages

1. Market spread. If you buy an ETF that has low volume the bid/ask spread can be significant (same as for a stock). For example, if the bid price is $100 and the ask price is $105 the ETF would need to gain 5% before you break even. For most widely traded ETFs the spread is very low. This is the hidden cost of an ETF (much like a front load fee for mutual funds). Blondie commented that he is reviewing the following Asia (non Japan) index ETF: AAXJ. The bid price for this ETF is $54.08 (as of December 31, 2009) and the ask price is 57.80. This is fairly high and I would not buy it. This was caused by the volume of the trades for the day. The higher the volume, the lower the spread.

2. Net Asset Value (NAV). Mutual funds are always the current marketing value of the underlying stock. This is not always the case with ETFs. ETF value is set by the market price which can cause a discount or premium to the share price. So the share price can be lower than the NAV of the underlying shares - it could also be higher. Lower NAV is usually a reflection of low volume of the ETF.

Blondie was also looking to find BRIC index ETFs. The following are BRIC index ETFs:

- S&P BRIC 40 SPDRS (BIK): up 66.9% year-to-date
- Claymore/BNY BRIC (EEB): up 66.1% year-to-date

The yield for these index ETFs are around 2.5% - more than a 3 year CD. Next week I will talk about these BRIC ETFs and decide whether I should add to my portfolio for 2010 and, if so, which one (or both).

If you have any suggestions for future blogs please leave a comment. The following are some possibilities:

Ways to play world currencies
Inflation hedges
How to short US treasures (with yields increasing in the future for treasures)

Please leave comments.


Paul