Three New ETPs for the New Year

Despite all the new ETP launches in 2010, there are still market niches to be filled

Morningstar ETF Analysts 10 January, 2011 | 12:14AM
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2010 was an exciting year for exchange-traded product (ETP) investors. Transparency increased, on-exchange liquidity rose, and intensifying competition amongst providers was marked by a raft of newly launched “me-too” products sporting lower expense ratios than existing competitors. But perhaps one of the most interesting developments was the number of new products that opened up new opportunities for investors. One example is the iShares Markit iBoxx Euro High Yield (SHYG) ETP, launched in September, which gave investors access to high yield European corporate debt in an ETF wrapper for the first time. In total, there were 327 new ETPs launched across Europe in 2010, including 140 equity ETFs, 75 commodity ETPs and 31 fixed income ETFs. Despite the plethora of new ETPs launched in 2010, there are still niches to be filled by enterprising ETP providers. Here we highlight three ideas for new ETPs that we think could benefit investors in 2011 and beyond.

Leverage for Long-Term Investors
The problem with the current leveraged ETPs is that while they are useful for short-term traders, they are unsuitable for long-term investors because of the unfavourable effects of compounding daily leverage. In a volatile market, holding onto a two- or three-times leveraged (or inverse) fund for an extended period is almost certain to lead to an adverse investor experience, whether or not the investor in question guessed correctly on the subsequent direction of the market. But there are methods available to mitigate this problem.

Because leveraged ETPs use swaps to track the performance of their index, it is a fairly simple exercise to change the leverage time horizon from daily to monthly by changing the terms of the swap. While this would not completely eliminate the problems caused by compounding in a volatile market, it would drastically reduce them. This would especially be the case if the leverage was limited to 1.5 times instead of two or three times, as the drag of frequent compounding become more pronounced with increasing leverage.

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Morningstar ETF Analysts  research hundreds of ETFs available to European investors. The Morningstar Rating for ETFs is based on a risk-adjusted performance measure.