Five Extreme-Rated ETFs

When moving to the high end of the risk band, sometimes there can be a fine line between investing and speculating. Morningstar's ETF research team is not averse to taking risks if we think that the potential upside is significant. However, there are times when visibility is so uncertain that gambling may be a suitable alternative.

To help us assess the uncertainty of an ETF, we can utilize the work of Morningstar's equity research team, which covers more than 2,000 stocks. For every stock under coverage, our analysts determine an uncertainty rating. This rating is their assessment of business risk as well as how tightly they feel they can bound the fair value estimates. Company-specific metrics that influence the uncertainty rating include sales predictability, operating and financial leverage, and exposure to contingent events. Think about the difference between predicting the future of  Coca-Cola (KO) versus some small biotech with one unapproved product in the pipeline and you have the idea.

Companies have their own set of factors that can influence the uncertainty rating, but our analysts also consider macro risks. Unstable economies and unpredictable governments can greatly impact companies and their investors. Former investors in Russian oil concern Yukos can attest to this. You can find more information describing how our equity analysts determine uncertainty ratings here.

We searched for ETFs that currently hold a high percentage of stocks carrying an "extreme" uncertainty rating. When our analysts designate a company's uncertainty as extreme, they will not recommend that investors purchase the stock at any price. Investors should consider that the diversifying benefit of an ETF can lower the risk inherent in some industries by holding a single stock. For example, the innate risk in purchasing one biotech concern that will live or die based on the approval of a blockbuster drug is much higher than buying a basket of biotech firms where there will be winners and losers. Thus, purchasing an ETF that invests in biotech stocks is much safer than buying one stock.

For some ETFs, though, the inherent risks affect many of the companies instead of just a select few. The list below contains some of the most unpredictable ETFs in our coverage universe. These could be choices for a very risk-seeking investor, or one who is willing to find the nearest roulette table and bet it all on red.

 Claymore/MAC Global Solar Energy (TAN)
 Market Vectors Solar Energy ETF 
Concerns about high fossil fuel prices, global warming caused by carbon dioxide, and insufficient generation supplies to meet growing demand have all given the renewable energy industry new life. Throw in federal tax subsidies for electric production and state-mandated renewable portfolio standards in the United States, in addition to even stronger demand globally, and the next several years look set to be prosperous times for alternative energy producers and developers alike. Perhaps the most intriguing untapped resource is solar energy, and Claymore/MAC Global Solar Energy ETF provides a direct avenue for investors seeking exposure to this growing sector and is the vehicle of choice for investing in the solar sector, in our view. Another ETF to consider is the Market Vectors Solar Energy ETF.

Claymore/NYSE Arca Airline 
There have been more than 180 bankruptcies in the airline industry over the past 30 years. Capital intensity, minimal customer-switching costs, and cutthroat competition have plagued the industry since deregulation in the late 1970s. Recent volatility in oil prices has only exacerbated the industry's structural issues.

Market Vectors Russia ETF (RSX)
Investors in stocks of Russian companies should be comfortable with a wild ride. Historically, the Russian government has shown little respect for property rights, and it has its hands in a number of businesses. The country just went through a recent war with neighboring Georgia. Russia is heavily dependant on oil and natural gas, and the slide in commodity prices and the value of the ruble in the second half of last year is still reverberating throughout the economy. We should note that Russian stocks have rebounded considerably off their lows.

iShares FTSE NAREIT Mortgage Plus Capped Index (REM)
Very little screams uncertainty these days like mortgages, and this offering from iShares tracks an index that invests in mortgage real estate investment trusts. Mortgage REITs do not directly invest in properties; they originate, acquire, and hold real estate mortgages and related loans. Mortgage REITs tend to be highly levered and quite sensitive to interest rates. Minute changes in spreads can significantly sway results.

 

  

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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.