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 Some 30 new single-country ETFs came to market last year focusing on
markets ranging from the United Arab Emirates to South Korea and
China. That brings the total to 202 single-country ETFs with $97.2
billion assets in the United States, more than double the number of
funds that existed five years ago. Dozens more - including one aimed
at Kazakhstan – are in registration with the U.S. Securities and
Exchange Commission.
Darshan Bhatt, chief investment officer of Jersey City, New
Jersey-based Glovista Investments LLC, which manages about $1.1
billion, picked Vietnam as a good place to invest, based on its
growth potential. Last year, Bhatt bought shares in the Market
Vectors Vietnam ETF.
"It's important for us to have these single country funds," said
Bhatt, whose firm runs a strategy that seeks to outperform the MSCI
Emerging Markets benchmark index, which can involve turning to "off
benchmark" nations like Vietnam that they favor.
The fund includes Vietnamese companies including food processing
firm Masan Group Corp, property conglomerate Vingroup and Sacombank.
Still, focusing on a single market overseas can carry risks and
requires monitoring. Government restrictions can limit the supply of
securities available to U.S. fund managers, and the funds' pricing
can be unpredictable because they can trade all day on U.S.
exchanges while the markets they track are closed.
As a result, the ETF prices don't always match the value of their
underlying assets, as they do in traditional mutual funds that price
once a day. Single country ETFs often sell at either a discount or a
premium, and they can hit unwary investors.
The average maximum premium for all single-country ETFs was 3.2
percent, while the average maximum discount was -2.9 percent, over a
12-month period, according to a Reuters analysis of data provided by
ETF.com. By comparison, the maximum premium at the SPDR S&P 500 ETF,
a major U.S. domestic ETF, was 0.14 percent and its maximum discount
was -0.08 percent.
THE PREMIUM-DISCOUNT CONUNDRUM
Premium and discount trading in international ETFs is the result of
a simple timing issue. Once an overseas market closes, say Japan,
the value of the underlying Japanese assets stay the same, while the
U.S.-listed ETF keeps trading. That means that for most of the U.S.
trading day, the U.S.-listed Japanese ETF is trading based on
expectations of how the underlying market is going to perform the
next day.
"As the day goes on, the net asset value (NAV) gets more and more
stale," said David Garff, president of Walnut Creek,
California-based Accuvest Global Advisors, which invests in a range
of country ETFs.
A 1 or 2 percent premium or discount is not alarming on a typical
trading day, but a surprise economic policy announcement or
unforeseen event could make those premiums double or triple,
analysts said.
When the Bank of Japan made a surprise announcement on Friday, Oct.
31, last year that it would be expanding its massive stimulus
spending, the iShares MSCI Japan ETF spiked to a 6.8 percent premium
on the following Monday, Nov. 3 - a day that Japanese markets were
closed for a national holiday.
PLAYING, OR PAYING, THE PRICE
Investors can take advantage of those price divergences, by using
discounts as opportunities to buy into markets they like anyway,
Glovista Investments' Bhatt said. But unaware investors may get
stuck paying a premium for an ETF without even understanding that
they are doing so.
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One afternoon last year, for example, Bank of America Merrill Lynch
received an order for $1 million worth of shares of the iShares MSCI
Japan ETF, at $12 a share – a price that included a 2 percent
premium because investors were expecting Japanese shares to rise
overnight.
Japanese stocks did rise but the ETF did not move up with it - that
bump had already been priced in by U.S. buyers. "We had to explain
that the ETF was projecting the premium already," said Sanjay
Chablaney, director of ETF trading at BofA, at a conference.
U.S. investors also have to consider currency exchange rates given
the stronger dollar, which can cut into total returns generated in
weaker local currencies abroad.
Investors have been turning to currency hedged ETFs, which strip out
the effect of a region's currency on the performance of a given
fund.
The difference can be substantial. The iShares Currency Hedged MSCI
Germany ETF, for example, has had a 22 percent YTD return so far in
2015, compared to a 7 percent YTD return for the unhedged iShares
MSCI Germany ETF.
CHOOSING COUNTRIES
Government restrictions in overseas markets, such as taxes or limits
for offshore investors, can also add a layer of uncertainty to
single-country funds as they can create a prolonged period of
trading at a premium. That's because a surge in investor demand in
an ETF that can only create a limited number of shares a day may
cause a fund to diverge from the true value of its underlying
assets.
Deutsche Bank AG, for example, had to limit creations in its China
A-Shares ETF late last year after nearly maxing out on its
government-issued quota, which caused the fund to trade at a fairly
consistent premium of several percentage points for most of late
last year before reaching a maximum of 7.2 percent premium in
December. It last traded at just under a 1 percent premium.
Because these price disparities can be extreme and because certain
markets are not liquid enough, investors shouldn't count on every
single-country ETF in the pipeline making it to market. Van Eck
Global, one of the largest U.S. providers of single country funds,
has had a Saudi Arabia ETF in filing since 2012. But with tight
Saudi restrictions on foreign investments that limit access to U.S.
fund managers, they have not yet been able to receive the go-ahead
from U.S. regulators.
"We are just ready and waiting," said Van Eck Global's ETF product
manager Amrita Bagaria. "A lot of people believe the Saudi market
will finally be open to foreign investors sometime this year."
(Reporting by Ashley Lau in New York; Additional reporting by
Jessica Toonkel; editing by Linda Stern and John Pickering)
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