How Facebook Will Sneak Into Your ETFs

It's the most closely watched initial public offering in a long, long time, and it surely will be one of the largest single IPOs in U.S. history.

What--you haven't heard that Facebook is going public?

As the insanely popular social-networking giant begins life as a public company on Friday, May 18 at an implied market capitalization of $93 billion to $104 billion, exchange-traded product investors may find themselves wondering what exchange-traded funds or exchange-traded notes will soon count Facebook as one of its holdings.

My colleague, Morningstar equity analyst Rick Summer, recently laid out his pre-IPO thoughts on Facebook's business model, concluding that the company's "social graph" indeed means that the company has a wide economic moat, which our equity analysts define as having sustainable competitive advantages. At the same time, Rick expressed concerns about Facebook's permanent lack of visibility into advertisers' return on investment for their ads on the site. He also highlighted the fact that the company's valuation is pretty full at its proposed offer price, trading at some 59 times the company's estimated 2012 earnings.

However, investors who see Facebook as undervalued and want to invest but also desire the protection of diversification can consider an ETF. So what is the best way for an ETF to gain exposure to Facebook?

What Kind of Company Is Facebook?
First, a word on classification. Investors should be aware of the investment world's general murkiness when it comes to categorizing Internet-oriented companies. Broadly, Internet companies are engaged either in Internet commerce (think Amazon.com AMZN, Priceline PCLN) or Internet services (for example, Google GOOG, Juniper Networks JNPR, and Yahoo YHOO). But Wall Street thus far has assigned some Internet companies to the consumer services or consumer cyclical industries, others to the media or business services realms, and still others to the specialty retail sector. What Wall Street seldom does, however, is lump all Internet companies into a single Internet "bucket," when it comes to coverage. Some niche investment products--notably, ETF First Trust Dow Jones Internet Index FDN--focus solely on Internet companies, but most do not.

We expect the investment community to lump Facebook in with Internet services companies like Google and Yahoo.

A Relatively Small Float Means Relatively Small Positions in Some ETFs
We have taken a close look at some ETFs and ETNs that we think would be most relevant for an investor seeking exposure to Facebook. In particular, we have studied their prospectuses to get a sense of what kind of position Facebook would occupy in these funds, and how soon before Facebook would appear as a holding. This is because most ETFs require a "seasoning period" for companies that have just gone public, meaning that Facebook won't necessarily be held in all of the below ETFs on its first day of trading.