Battle of the Country ETFs
June 30, 2008

SAN DIEGO (ETFguide.com) - One easy way to invest in foreign stocks is through exchange-traded funds (ETFs) designed to follow the stock market in specific country.

While most individual investors are probably best served owning more broadly diversified foreign stock funds, single country ETFs offer a range of unique opportunities.

Country ETFs save you from the perilous task of handpicking individual stocks in faraway lands. Instead of owning a few stocks in a particular market, you get a diversified basket.

Another under-recognized benefit of country ETFs is instant currency diversification. This is a built in feature by virtue of the fact that stocks within country ETFs are traded on foreign exchanges in their local currency.

Because they typically focus on just a handful of stocks from one selected country, these ETFs give precise and concentrated exposure. While this may increase an investor’s risk, it also increases the potential for super-sized gains.

Barclays Global Investors (BGI) manages 29 single country ETFs that trade under the iShares brand. First introduced in 1996, these were the earliest single country funds to hit the ETF marketplace. In terms of assets, Brazil (Ticker: EWZ), Japan (Ticker: EWJ), and China (Ticker: FXI) rank among BGI’s most popular country ETFs.

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“I would say that financial advisors and investors typically like to use the MSCI single country iShares Funds because they fit together in a portfolio,” said Christine Hudacko, a BGI spokesperson. “They can construct a precise portfolio using a single country fund family that has
the same methodology.”

Another lineup of country ETFs known as the “NETS” was recently launched by Northern Trust Investments.

“NETS ETFs track the dominant indexes for major foreign markets,” said Steven Schoenfeld, Chief Investment Officer, Global Quantitative Management at Northern Trust. “These are the benchmarks that local investors use to define ‘The Market,’ and the underlying indexes for those country’s primary derivative contracts and locally-listed ETFs.”

To illustrate, the NETS CAC40 Index Fund (Ticker: FRC) follows the CAC40, a blue chip index of France’s top publicly traded stocks like Total SA, Bnp Paribas, and Sanofi-Aventis SA. The Paris Bourse listed companies with the largest size by market capitalization are chosen from a group of 100 to be members inside the CAC40.

Explaining their strategy, Schoenfeld said “ NETS is bringing these very familiar indexes -  like TOPIX, DAX, CAC-40 and Hang Seng – closer to US investors, enabling them to invest abroad just like local market participants.”

Even though the indexing strategies of BGI and Northern Trust’s ETFs both follow a similar approach of passively selecting stocks and weighting them by market capitalization, there are some notable differences.

The NETS follow instantly recognized equity benchmarks whereas the iShares follow MSCI constructed indexes that may or may not include some of the same securities. BGI also offers country ETFs that follow non-MSCI indexes. Even though MSCI indexes may lack the familiarity you get with a popular benchmark, in some cases, they may do a better job of representing a particular equity market.

One example is the iShares MSCI Germany Index Fund (Ticker: EWG) which is more diversified than the NETS ETF tracking the popular German DAX index (Ticker: DAX). EWG contains 62 stocks compared to just 30 for DAX. Also, EWG has a larger representation to smaller growth companies. The median market cap for stocks inside EWG is $11 billion versus $41 billion for DAX.

In some instances, greater diversification through more holdings for the MSCI country indexes isn’t always true. For example, each of the NETS ETFs tracking Australia, Hong Kong, and Japan held more stocks than their iShares MSCI rivals.

Analyzing the underlying index is a crucial step for ETF investors in making the right investment decisions.

“A popular local index may not serve the needs of investors in other markets,” adds Hudacko. “For example, the QQQQ is arguably the most successful ETF in the US, but it has not done well in Europe.”

Another important aspect to consider is expenses.

The NETS charge annual expense ratios of just 0.47 percent, which is lower compared to most competing country ETFs. All things being equal, there’s little reason to pay more.

Also, don’t neglect the full breadth of single country opportunities in the ETF marketplace.

While other ETF providers may not necessarily offer an abundant number of country focused funds like BGI or Northern Trust, compelling choices abound. InvescoPowerShares, State Street Global Advisors, and WisdomTree each offer their own versions of country ETFs.

Whereas most country ETFs attempt to capture the performance of a local market, the InvescoPowerShares and WisdomTree ETFs focus on picking the best stocks within a market by using fundamental measures like earnings or dividends. As a result, expense ratios tend to be higher and performance won’t necessarily follow the market. Areas covered include India (Ticker: EPI) and Japan (Ticker: PJO).

Top performing country ETFs so far this year include Brazil (Ticker: EWZ) ahead by 9.8 percent and Canada (Ticker: EWC) up by 3.5 percent.

Underperforming country ETFs are China (Ticker: GXC) down 25.7 percent and Belgium (Ticker: EWK) off by 21.5 percent.

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