BUSINESSWEEK ONLINE : SEPTEMBER 11, 2000 ISSUE
BUSINESSWEEK INVESTOR All Abroad for Exchange-Traded Funds They make global investing easier and cheaper When it comes to investing abroad, even sophisticated stockpickers find it safer and simpler to hire others to do the work for them. In the past, this has meant buying an international mutual fund or its quirky cousin, the closed-end fund. But each has drawbacks, not least of which is high costs and a tendency to generate big tax bills. Now there's a third choice: the exchange-traded fund, or ETF. This relative newcomer solves some of the biggest problems associated with its rivals. The result: a powerful tool for global investors. ETFs combine elements of stocks and index funds. They go by fanciful names: SPDRs, or ''Spiders,'' invest in the Standard & Poor's 500-stock index, Qubes buy the NASDAQ 100, and Diamonds track the Dow Jones industrials. Index fund shares are priced once a day, but ETF shares are listed on the American Stock Exchange and, like stocks, trade continuously. They can also be bought on margin or sold short. MORE ARE COMING. International ETFs have been around since 1996. First called Webs, they have since been renamed iShares. They track the indexes that Morgan Stanley Capital International developed for individual countries. There's an iShare now for each of 20 countries, including Malaysia, Hong Kong, Mexico, Britain, and Germany. Plans call for as many as five more, including for Portugal and Greece. And two multicountry iShares track the S&P Europe 350 and the MSCI European Monetary Union indexes. More multicountry ETFs are on the way, including ones to track the large-cap companies in the Dow Jones Global Titans Index and the S&P Global 100 index. But if you hope to use ETFs to invest in global sectors, such as technology or health care, you'll have to wait. Although many ETFs focus on U.S. market sectors, Barclays Global Investors, which sponsors iShares, says no international-sector versions are planned. Cost-conscious investors will want to consider using ETFs. They're cheaper than actively managed funds: Expense ratios on single-country iShares range from 0.84% to 0.99% of assets, vs. an average of 1.89% for single-country closed-end funds, and 1.60%, on average, for international mutual funds. But if you're after broad international exposure, you can get more diversification at a lower cost from an international index fund than from a cluster of iShares. Even the multicountry iShares for Europe have expense ratios twice as high as that of the Vanguard European Stock Index Fund. You'd also be better off with a conventional mutual fund if you want to invest small sums at regular intervals. That's because ETFs, like stocks, are bought and sold on commission, making them most cost-effective when you trade large blocks. ETFs have other quirks. Some deviate so sharply from their underlying indexes that they can scarcely be called index funds. There's a reason for this: U.S. securities rules bar funds from putting more than 25% of their assets into a single investment. So when a stock dominates a country's markets, its iShare cannot precisely replicate that index. Ericsson, for instance, accounts for 45% of the Swedish index, but only 23% of the iShare. This caused the iShare to lag its index by 14.8 percentage points for the 12 months through June. Other iShares that deviated from their indexes by three percentage points or more are those for Canada, Malaysia, the Netherlands, Spain, and Switzerland. There are no iShares for some countries, including Ireland and India. And if you want a fund to protect you from the risk of a falling dollar, you'd better look elsewhere. While some mutual funds hedge currency risk, iShares do not. Still, with ETFs you can trade in ways you cannot with other funds. Conventional mutual funds don't allow targeted bets on countries: The handful that focus on single countries are almost all Japan funds. Selling an ETF short is a piece of cake, while short sales of closed-end funds are so complicated that even the pros shy away from doing them. So ETFs are often your best tool to play specific trends--especially if you don't want to disturb positions you already have. Say you wake up one morning to bullish news on Singapore. By buying its iShare, you can boost the share of your portfolio tied to that market. Conversely, if Japan's recent interest rate hike makes you nervous, you don't have to sell your Japan fund--which might trigger tax bills. You can just sell the Japan iShare short. By betting against the Nikkei index while your Japan fund wagers it will rise, you hedge your exposure. BIGGEST EDGE. ETFs are also more tax-efficient than their rivals. Both funds and ETFs distribute capital gains to shareholders when they sell a profitable stock. But unlike conventional funds, which are sometimes forced to sell stocks to meet shareholder redemptions, ETFs unload shares only when the indexes they follow change. And that doesn't happen too often. Recent data indicate that international iShares turn over 28% of their holdings per year, vs. 45.7% for closed-end country funds and 89% for mutual funds that invest abroad. Perhaps the ETFs' biggest edge is performance: Over the past 12 months, international iShares rose 11.9%, vs. 8.4% for single country closed-end funds, according to Wiesenberger, Thomson Financial's fund-tracking unit in Rockville, Md. For the past three years, international iShares returned an average of 6% a year, against 4.5% for the shares of closed-end country funds. ETFs are less likely than closed-end funds to trade at a discount to the market value of their holdings. Unlike conventional mutual funds, closed-end funds float a fixed number of shares that trade on exchanges. If there's a lot of demand for a fund's shares, its price can rise above its portfolio's market value. But because demand has been weak, closed-ends usually sell for less than their worth. Buying at a discount is good, of course, but there's no guarantee your fund's discount won't be wider when you want to sell. ETFs aren't entirely immune to discounts. When Malaysia imposed controls on foreign investment in 1998, its iShare briefly traded at a 30% discount, according to Wiesenberger. Although extreme, this is not the only example. In a dramatic sell-off, investors should expect to see discounts on ETFs, says Michael Porter, a closed-end country fund analyst at Salomon Smith Barney. Still, such deviations should always be temporary, because when an ETF slips to a discount, arbitrageurs go to work. Barclays and other ETF sponsors stand ready to swap ETF shares for the stocks in the indexes they track. So the arbs buy discounted ETF shares and realize the true value immediately by exchanging them for their underlying stocks. This works in reverse when ETFs trade at premiums. Unlike ETFs, however, closed-end funds don't have arbitrageurs bringing their prices back in line. Historically, deep discounts on closed-ends have been buying opportunities--and investors can now buy closed-end country funds for an average of 80.5 cents for $1 of assets. ''This is an excellent time to buy,'' says Thomas Herzfeld, whose eponymous Miami brokerage firm specializes in closed-end funds. But don't be so sure: The growing popularity of ETFs may sap demand for country funds--and just drive those discounts deeper. BY ANNE TERGESEN _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS The New Global Investor CHART: Global Markets Are Growing Fast...Shrinking the U.S.'s Dominance...And Internet Use Abroad CHART: The Case for Global Sector Investing Conquering a Slice of the World TABLE: Spanning the Globe All Abroad for Exchange-Traded Funds TABLE: How ETFs Stack Up against Their Rivals A Talk with a Global Strategist TABLE: Sargen's Picks VIDEO: Investing in the Global Village So Who Needs Foreign Investing? TABLE: Global Action Around the World in 80 Clicks TABLE: Going Global with the Web INTERACT E-Mail to Business Week Online

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