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The Worst New ETFs of 2007

Our list of the ill-conceived and sublimely wacky ETFs that launched last year.

Last week we presented our short list of the "Best New ETFs of 2007." But when the ETF universe nearly doubles within 12 months, as it did last year, there are bound to be some duds. So, we'd be remiss if we didn't also tally up the worst that 2007 had to offer. These are ETFs that for reasons of (poor) timing, (nosebleed) valuation, or other factors (inexplicable daffiness) left us straining for adjectives.

"Don't Tase Me, Bro!"
ETF providers launched a number of funds in categories that, to put it charitably, looked frothy entering 2007. Emerging markets and real estate topped that list, though natural-resources funds weren't far behind. All told, 72 such ETFs launched in 2007.

No, there's not necessarily cynical intent behind all of these launches. For instance, some can argue that despite their strong run, commodities aren't yet stretched given seemingly unquenchable worldwide demand and constrained supply.

Yet, too often investors pile into offerings like the following just as performance--which had been white-hot only months before--is about to cool off, and they get burned in the process.

  • SPDR S&P China (GXC) and First Trust ISE Chindia  
    These markets have been smoking in recent years. Not surprisingly, they look rich to our eyes. For instance, First Trust ISE Chindia was recently trading at a 5% premium to our fair value estimate, reflecting the overheated state of the Chinese and Indian markets. The same also applies to many of the SPDR offering's holdings, which have prospered in recent years amid an economic boom in China.
  • Adelante Shares Real Estate and iShares FTSE NAREIT Funds (Various)
    XShares (advisor to the Adelante Shares) and Barclays (manager of the iShares) launched these funds into the teeth of the real estate correction, which continues unabated. The returns tell the tale: If you'd bought any of the seven Adelante ETFs at inception, you'd have lost roughly 15% of your investment by year's end. And woe to investors in the iShares FTSE NAREIT funds, which fell 22% on average since their May 2007 launch.

Timber!
And then there are the funds that seem calculated to exploit investor fears, or simply misinformation. For instance, we've seen a bevy of "water" funds (more on that below), a nuclear energy fund, and even a "global vaccine" fund. Yet, we're giving the booby prize to Claymore Clear Global Timber (CUT), an ETF that launched in November 2007.

Timberland investing--that is, investments in timber forests--has been all the rage among institutional investors, who have been enraptured by the commodity's sturdy fundamentals and low correlation with major asset classes. Yet, there's a big difference between investing directly in timberland and taking a stake in publicly traded forest product companies like  International Paper (IP), which is what the Claymore fund does. How big a difference? The Campbell Group, which is a large timberland investment manager, estimated that timberland returns are weakly correlated with those of paper and pulp producers, meaning that the latter is hardly a substitute for the former. In short, there are a number of factors--such as capacity, cost efficiency, exchange-rate fluctuations, and capital-intensiveness--that drag on the returns that any of the paper producers earn from their timber portfolios.

One wonders if investors considering the fund as a "timber" play--likely because they've heard about timberland-investing's supposedly virtuous traits--realize this. We doubt it.

Fund Ideas That Were Formerly Weird, But Which Now Occur with Such Frequency That They Have Come to Seem Normal (Inspired by "News of the Weird")
These are the ETFs that defy ready categorization but for their all-too-familiar brand of wackiness (only in the ETF world would you dare call a water ETF "passe"). Here were a few of this year's prevalent themes:

  • ETFs That Don't Add Up (25): The compounding arithmetic of leveraged ETFs doesn't work over extended (longer than one-day) periods. So, you literally don't get your money's worth. And, with leveraged short funds, another 25 of which made their debuts in 2007, you're not only making what's traditionally been a lousy bet--the short side of a trade--but you're doubling-down.
  • ETFs with Inscrutable Names (2, though arguably more): BearLinx Alerian MLP Select ETN BSR, anyone?
  • Unclear-on-the-Concept ETFs (at least 3): Now who hasn't thought to themselves, "Gosh, wouldn't it be great to be able to buy an ETF that held the stocks of  Wal-Mart's (WMT) suppliers?" (FocusShares ISE-Revere Wal-Mart Supplier ). Or, "Is there a way to play excema?" (HealthShares Dermatology & Wound Care Fund ). Or, "I'm so tired of flipping closed-end funds. Why can't there just be an index of these things?" (Claymore CEF GS Connect ETN (GCE)).
  • Liquid ETFs (4): No, we don't mean ETFs that trade at tight bid/ask spreads. We're talking about the fluid state of matter, as in Claymore S&P Global Water (CGW). Too narrow? Fear not. There's also the more-generic First Trust Nasdaq Clean-Edge Liquid (QCLN). But if that doesn't tempt, either, there's always the sewer--iShares S&P Global Infrastructure (IGF) or SPDR FTSE/Macquarie Global Infrastructure 100 (GII) beckon.

Disclosure: Morningstar licenses its indexes to certain ETF and ETN providers, including Barclays Global Investors (BGI), First Trust, and ELEMENTS, for use in exchange-traded funds and notes. These ETFs and ETNs are not sponsored, issued, or sold by Morningstar. Morningstar does not make any representation regarding the advisability of investing in ETFs or ETNs that are based on Morningstar indexes.

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