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Our Take on Five of the Most Popular New ETFs

Are these newly minted funds worthy of your attention?

As editor of Morningstar ETFInvestor I've had to work fast and furious to keep up with the explosive growth in the ETF market. Just this year, more than 200 new ETFs have been launched, and a few of these new offerings have really caught on with investors. Here's my take on some of the most popular ETFs from the class of 2007.

CurrencyShares Japan Yen Trust (FXY)
As its name suggests, this ETF provides shareholders exposure to the Japanese yen. Investors have flooded it with cash since its January launch, no doubt looking for a way to profit from the dollar's recent weakness. But short-term currency bets can be difficult to pull off successfully. Not only do you have to handicap a myriad of complex economic factors, but you've also got to get the timing right. Even experienced economists with reams of data at their disposal have a tough time making accurate currency calls. 2005 provides a case in point. Citing the burgeoning U.S. trade deficit and our growing fiscal deficit at home, many economists predicted that the greenback would weaken that year. Nevertheless, the dollar stubbornly rose in value against major currencies in 2005, and a bet against it would have gone sour fast.

Sure, I think it makes sense for long-term portfolios to have exposure to a variety of currencies, but the most effective way to do that is by investing in a broadly diversified foreign equity fund that doesn't hedge its currency exposure. That brings us to the next-most popular new ETF.

Vanguard FTSE All-World Ex-US ETF (VEU)
Until this year, there was only one ETF that provided broad exposure to international stocks: iShares MSCI EAFE Index EFA. Because it faced little competition, it was able to gather scads of assets, and it currently weighs in at $48.9 billion in assets.

But new ETFs, like this new Vanguard fund, have taken on  iShares MSCI EAFE Index (EFA) in 2007, and that's a welcome development for investors. The iShares fund isn't an ideal one-stop core foreign fund because it excludes emerging markets, as well as Canada. This new ETF from Vanguard doesn't suffer from those shortcomings. Plus, its price is certainly right. It charges just 0.25% in expenses, compared with the iShares fund's 0.35% levee.

Indeed, Vanguard FTSE All-World Ex-US is one of my favorite new ETFs of 2007, and apparently, I'm not alone. Since its debut in March, it has amassed more than $800 million in assets. Granted, it'll take this fund a long time to catch up to iShares MSCI EAFE's massive footprint. But I look for the Vanguard fund to continue to grow market share. It's a cheap and convenient way to add broad international diversification to a long-term portfolio. Index investors looking to make periodic purchase over time should check out the conventional share class of this fund: Vanguard FTSE All-World Ex Index .

UltraShort Financials ProShares (SKF)
Like all ProShares ETFs, this fund provides leveraged exposure to its market segment. Specifically, it provides two times the inverse exposure of the Dow Jones US Financials Index. For example, if its benchmark declines in value by 2%, this ETF aims to increase its value by 4%, and vice verse.

The subprime mortgage mess has weighed on financial stocks, and the investors who have piled onto this fund obviously think the sector has further to fall. But I have a very different take on the sector based on the work of Morningstar's equity research. I view the recent downturn as a rare opportunity for long-term investors to scoop up some high quality financial institutions at bargain-basement prices.

Several financial ETFs look cheap right now, and my colleage Haywood Kelly points out in this article.  iShares Dow Jones US Financial Services (IYG) boasts a price/fair value ratio of 0.84, which indicates that it's trading at a 16% discount to its aggregate fair value. Similarly,  Financial Select Sector SPDR (XLF) has a price/fair value ratio of 0.88. And both of these ETFs are dominated with attractively valued wide-moat firms like  Bank of America (BAC),  JP Morgan (JPM), and  American Express (AXP).

For those seeking a more targeted play on the sector,  KBW Bank ETF (KBE) is worth a look. It's loaded with multinational and super regional banks, many of whom possess enduring competitive advantages. Yet it is current trading at an 17% discount to its aggregate fair value.

Vanguard Total Bond Market ETF (BND)
When 2007 began, investors had only six fixed-income ETFs to choose from. As of this writing, there are now 35 bond ETFs on the market, and more are on the way.

Vanguard's entry in to the bond ETF arena was a positive for investors. First of all, it added pressure to lower fees. Vanguard's bond ETFs debuted with expense ratios of 0.11%. That forced Barclay's to lower the price tag of the iShares bond ETFs that were already on the market. Because expenses take a larger bite out of bond returns, it's great to see the competition bring costs down. And because you have to pay a brokerage commission with each ETF trade, the lower the expenses the better.

Vanguard Total Bond Market ETF has more to offer than just low fees. It offers wide-ranging exposure to the bond market, making it a convenient one-stop bond ETF. It's also more diversified than the competition.  iShares Lehman Aggregate (AGG), which tracks the same benchmark, holds just 130 individual bonds, whereas the Vanguard fund holds thousands of securities. That increases this ETF's chances of tracking its benchmark more closely and it provides shareholders greater diversification.

PowerShares DB Agriculture (DBA)
This ETF provides exposure to agriculture commodities by investing in futures contracts for corn, wheat, soybeans, and sugar.

Regular readers of Morningstar ETFInvestor know I'm not fond of ETFs that track narrow segments of the commodity market. They're just tools for speculators in my view. Trying to make short-term calls on the direction of fickle commodity prices is a quick way to get burned. So I'd steer clear of this ETF and the others like it, such as Unites States Natural Gas (UNG), another new fund that has also been popular with the fast-trading crowd.

That's not to say that I don't think there's a justifiable argument for investing in commodities. Because they tend to zig when the broader market zags, commodity funds can be effective long-term diversifiers, and for that task, I prefer funds that provide exposure to a wide range of commodities. My favorite is  iPath Dow Jones-AIG Commodity Index ETN (DJP). I like it because its benchmark spans 19 different commodities, and it caps its exposure to a single commodity segment at a third of assets. As a result, this ETN's benchmark is less energy heavy than the competition, and it's has been less volatile historically than other commodity indexes. But it is by no means immune from the turbulence that comes with commodity investing, so it's best to limit your exposure to just a small slice of your portfolio, say 5% or so.

Sonya Morris is editor of Morningstar ETFInvestor, a monthly publication that offers Morningstar's take on the ETF market. To learn more, click here.

 

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