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By The Numbers: ETF Investment And The Indian Market

By Utkarsh Agrawal Since the introduction of ETFs, the dynamics of investing has changed dramatically. Apart from being more transparent, with lower costs and improved tax efficiency, ETFs have helped create the opportunity for smaller investors to access asset classes previously available only to institutional investors. Emerging markets tend to be riskier than developed markets, but can also offer diversification opportunities. With emerging market ETFs, it has become possible to incorporate the objectives and constraints of investors who desire exposure to emerging markets in their portfolio construction process. Among emerging markets, India has been one of the preferred countries. The assets under management (AUM) and the number of the ETFs that provide exposure to India have increased tremendously. All of these ETFs are based on Indian equities. As of July 2015, there were 27 of them, with combined AUM of USD 12.80 billion, domiciled across seven countries (see Exhibit 1). The U.S. has been the greatest contributor in terms of both AUM and the number of ETFs, followed by France, Singapore, and other countries. Since August 2015, the combined AUM has decreased by more than USD 2.27 billion, amounting to a decline of almost 18%, and it stood at USD 10.53 billion as of September 2015. This reduction in AUM has also contributed to the volatility of the equity market and the exchange rate in India. Exhibit 1: International Equity ETFs That Provide Exposure to India Source: Morningstar. Data as of Sept. 30, 2015. Chart is provided for illustrative purposes. As opposed to the international Indian ETFs, India’s domestic ETFs are not only limited to equities. They also include commodities, fixed income investments, and money markets (see Exhibit 2). As of September 2015, the total number of domestic ETFs was 51, and the combined total AUM stood at USD 2.09 billion. The proportion of domestic equity ETFs in the combined total AUM was almost 48%, at USD 1.00 billion as of September 2015. The AUM of the domestic equity ETFs in India account for just 10% of that of the international equity ETFs that provide exposure to India. The recent rise in AUM of India’s domestic equity ETFs can be attributed to the introduction of the Central Public Sector Enterprise (CPSE) ETF, as well as the investment by the Employees’ Provident Fund Organization (EPFO). The Central Board of Trustees (CBT), the apex decision-making body of the EPFO, has recently decided to invest in India’s domestic equity ETFs within the prescribed limit of 5%-15% of the total corpus. Exhibit 2: Domestic ETFs in India Source: Morningstar, Association of Mutual Funds in India and Reserve Bank of India. Data as of Sept. 30, 2015. Chart is provided for illustrative purposes. The S&P BSE SENSEX , India’s heavily tracked bellwether index, is designed to measure the performance of the 30 largest, most-liquid, and financially sound companies across key sectors of the Indian economy. As of September 2015, it has served as the underlying index to one international equity ETF, which provides exposure to India, and five domestic Indian equity ETFs. Over the past 10 years, ending in September 2015, the S&P BSE SENSEX has yielded an annualized total return of 13.32% in Indian rupees (see Exhibit 3). Apart from domestic Indian equity ETFs based on other indices, the EPFO will also invest in the domestic S&P BSE SENSEX ETF, leading to expectations of a further boost to the AUM of this established index. Source: S&P Dow Jones Indices. Data as of Sept. 30, 2015. Chart is provided for illustrative purposes. Past performance is no guarantee of future results. Disclosure: © S&P Dow Jones Indices LLC 2015. Indexology® is a trademark of S&P Dow Jones Indices LLC (SPDJI). S&P® is a trademark of Standard & Poor’s Financial Services LLC and Dow Jones® is a trademark of Dow Jones Trademark Holdings LLC, and those marks have been licensed to S&P DJI. This material is reproduced with the prior written consent of S&P DJI. For more information on S&P DJI and to see our full disclaimer, visit www.spdji.com/terms-of-use .

Reasons Why The United States Oil ETF Is A Sell

Summary 1-month return is -10.85%. Year-to-date return is -35.41%. USO is a Sell. Poor ROE for USO unsettles WTI crude oil investors. Upcoming OPEC meeting to provide no long-term relief. (click to enlarge) USO NYSE ARCA 3-Month Performance of Oil The United States Oil ETF (NYSEARCA: USO ) has been listed on the NYSE ARCA since 10 April 2006. The 30-day yield is 0% and the 12-month yield is 0%. The total net assets of the company are $2.80 billion. But the performance of USO has been anything but exemplary. With a year-to-date return of -35.58%, it is ranked among the poorer performing oil funds on the market. There is no price/earnings ratio to speak of either. The fund price is $13.11 (as at 30 November 2015) and the 52-week trading range spans $12.37 on the low end and $26.39 on the high end. The 1-year chart paints an even more disturbing picture in the sense that the stock has plunged 41.87% between November 30, 2014 and November 30, 2015, from $25.58 to the current trading price of $13.11. Here are some interesting metrics about United States Oil, to further illustrate why is a strong sell contender – despite the news of falling inventories, rising oil price projections, Fed rate hikes and declining WTI oil inventories for 2016 and beyond. Looking at the total market returns for the past 3 years we see the following: The year-to-date return is -35.58 % The 1-year return is -53.30 % The 3-year return is -25.87 % USO Fund Performance Overview More importantly, the performance of USO trails the performance of the index by almost 10%, with -26.14% for the year-to-date and an index year-to-date return of -15.43%. When compared to the S&P 500 index, the performance history of USO is equally bearish. The 10-year annualized return of the S&P 500 index is 6.84%, the five-year annualized return of the S&P 500 index is 13.69% and three-year annualized return of the S&P 500 index is 16.12%. USO has a significantly poorer performance record over 1 year, 3 years and 5 years. The worst year of course has been the period between November 2014 and November 2015 when the price of WTI crude oil dropped from over $120 per barrel to its current trading range in the region of $40 – $45 per barrel. Things to Look Out For in Coming Weeks As at 1 December 2015, the likelihood of a Fed rate hike following the December 15/16 Fed FOMC meeting is 76%. The dollar index is now over 100, and close to its 52-week high. The Euro for its part is faltering and is trading under the critical 1.06 support level. This is likely to decrease further when two things happen: the ECB decides to implement quantitative easing with additional stimulus measures to boost the money supply, and the Fed moves in the opposite direction with monetary tightening to increase interest rates. This will open up plenty of daylight between the euro and the dollar, sending the European currency closer to parity with the greenback. However, despite general market weakness in China and its impact on EM countries, we are seeing some positive movements in commodity prices around the world. Both gold and copper staged minor rallies, but the concern remains crude oil. In this vein, the USO fund will likely be driven lower on the back of several upcoming meetings and announcements by OPEC and non-OPEC producers. On Friday, 4 of December OPEC members will meet to discuss the issue of supply, demand and equilibrium prices for crude oil. For its part, WTI crude oil has been clinging to single digit gains over the past couple of days. The price of WTI crude oil dropped by 3.19% ($-1.33) over the past month. The price of Brent crude oil dropped 2.92% ($-1.31) since October 30, 2015. The 1-year forecast for WTI crude oil is $47 per barrel. For its part, United States Oil Fund of Delaware has the objective of having changes in its unit’s net asset values reflect the equivalent changes in the price of WTI crude oil from Cushing, Oklahoma. It operates as an oil futures price on the WTI crude oil futures on the NYMEX. The current fund managers are Ray Allen. How Crude Oil is Going to Be Impacted in the Weeks Ahead A big part of the problem with the oil markets is the oversupply. This is true of WTI crude oil, Brent crude oil and other crude oil suppliers. Oil companies are jockeying for position with one another, refusing to budge on market share considerations in favor of price considerations. A global supply glut is the order of the day and there are real concerns about a stronger USD, weakness in China and the possibility of a Fed rate hike. On the Nymex, crude oil for January delivery closed the week at $41.71 per barrel. This is now the fourth consecutive week of declines for oil futures traded in New York. For November alone, Nymex futures have declined by 10%. The EIA released a report detailing increases of 961K barrels of crude oil for its ninth consecutive gain in inventories. Now, US crude oil stockpiles stand at over 488 million barrels – the highest level in over 80 years. But it’s not only WTI crude oil that is feeling the pressure – it’s Brent crude oil too. On the ICE Futures Exchange in London, Brent crude oil retreated by 1.32% to close at $44.86. While there were some concerns about a potential conflagration between Russia and Turkey, that only led to a slight uptick in the oil price, but nothing strong enough to sustain higher prices. Concerns remain over the potential fallout of a larger regional war from Syria into Iraq, Iran, Jordan and other countries. But the most important upcoming announcement will be what is decided at the OPEC meeting on 4 December. This will be one of the most crucial meetings to take place in the final four weeks of 2015. Should OPEC member nations, led by Saudi Arabia, decide to cut output, the price of crude oil will rise moving into 2016. This will invariably have a positive effect on oil futures, oil funds like USO, and inflation rate targets for the US, the UK, the European Union, Japan and other countries. In fact, it is precisely the actions of the energy rich bodies like OPEC that can turn the global economy around. It is not that OPEC lacks the ability to effect change, it lacks the determination to do so. The majority of analysts – Banc De Binary among them – do not expect OPEC to come to any agreement about cutting oil production. That would be a blatant surrender to WTI and global pressures. There are low expectations ahead of this meeting, and even Russia – a key energy producer – has decided not to send an envoy. It is well-known that OPEC nations have deeper pockets to sustain plunging revenues and profits compared to WTI producers. It may well be a war of attrition taking place between both power blocs, but until such time as global demand is able to soak up global supply, prices will remain at historically low levels. US Oil Rig Count Expected by Baker Hughes on Friday Everyone is determined to defend market share at the expense of all else – even if it means putting themselves out of business. That is precisely what is happening with many oil producing countries around the world. High cost oil producers are feeling the pinch in a big way, and they are having to endure falling credit ratings, falling profitability and revenue streams, layoffs and the like. The bigger companies with lower costs of operations are now able to swallow up the smaller companies. Then of course there are the policy decisions of the European Central Bank and the Fed. The ECB is moving towards quantitative easing and the Fed is moving towards quantitative tightening. This will likely strengthen the greenback and make oil prices less affordable in an already flat-demand scenario. One of the things to look for this coming week will be the Baker Hughes report on US oil rig counts on Friday, 4 December. As greater numbers of oil rigs shutter operations, so US supply declines and inventories decline too. Falling numbers of US oil rigs in production is a double-edged sword for investors as it shows the US is incapable of maintaining operations at current prices. Falling numbers of US oil rigs will invariably be perceived negatively by investors in USO. Performance of Oil ETFs Exchange Traded Funds (ETFs) such as USO allow investors to access commodity markets for crude oil without actually taking futures contracts. Since USO has been one of the lower-ranked oil ETFs, it is worth considering other exchange traded funds. Among the strongest performers are the following crude oil ETFs on the US exchanges: The DB Crude Oil Dble Short ETN (NYSEARCA: DTO ) with a year-to-date return of 66.41% and a 5-year return of 140.02% The UltraShort DJ-UBS Crude Oil (NYSEARCA: SCO ) with a year-to-date return of 40.73% and a 5-year return of 102.05% The DB Crude Oil Short ETN (NYSEARCA: SZO ) with a year-to-date return of 35.66% and a 5-year return of 86.73% The United States Short Oil Fund (NYSEARCA: DNO ) with a year-to-date return of 31.98% and a 5-year return of 76.70% The VelocityShares 3x Inverse Crude Oil ETN (NYSEARCA: DWTI ) with a year-to-date return of 26.72% and a 3-year return of 183.02% The United States 12-Month Oil (US) with a year-to-date return of -30.24% and a 5-year return of -54.63% The Pure Beta Crude Oil ETN (NYSEARCA: OLEM ) with a year-to-date return of -33.39% and a 3-year return of -56.26% The DB Oil Fund (NYSEARCA: DBO ) with a year-to-date return of -35.29% and a 5-year return of -62.41% The DD Crude Oil Long ETN (NYSEARCA: OLO ) with a year-to-date return of -36.63% and a 5-year return of -60.39% The United States Oil Fund with a year-to-date return of -38.80% and a 5-year return of -67.48% The S&P GSCI Crude Oil Tot Red IDX ETN (NYSEARCA: OIL ) with a year-to-date return of -42.42% and a 5-year return of -71.32% The Ultra DJ-UBS Crude Oil (UCL) with a year-to-date return of -68.45% and a 5-year return of -93.18%

Differentiating Between Emerging Markets For Better Returns

Summary Emerging markets are often grouped together, but it’s better not to. Changes in monetary policies may be upon us and some countries should do better than others. Countries with sizable deficits are more likely to experience problems and should be avoided. The year 2015 has been a forgettable one so far for many emerging markets. For instance, the iShares MSCI Emerging Markets ET F (NYSEARCA: EEM ), which is the leading ETF for emerging markets is down by 11 percent this year when it comes to liquidity. By comparison, stock markets in countries such as the U.S. and Japan are at record levels. Some people may therefore feel that emerging markets are more of a bargain and have more upside still left in them. A long position in emerging markets is an option worth exploring from this standpoint. On the other hand, some may argue that the worst is not over for emerging markets and there is still some downside left. Avoiding long positions or even initiating short positions in emerging markets is the way to go if one agrees with this viewpoint. A third option is to break down emerging markets into smaller groups and pick the one that is most likely to do well in the future. The group that is most likely to underperform is to be avoided or even shorted as an alternative or as an addition to long positions in emerging markets. How to differentiate between emerging markets While they may be grouped together under a single name, the fact remains that emerging markets are more often than not very different from one another. Some countries have little if anything in common with other emerging markets despite all of them being referred to as emerging markets. It may therefore be a good idea to think of emerging markets not as a single group, but rather as several distinct groups. There are many ways one could divide emerging markets into separate groups. For instance, some may be democratic countries, while others are more autocratic. Some rely heavily on the export of raw commodities, while others depend on the export of manufactured goods. There are lots of options if one wants to break down emerging markets into smaller groups. However, one way that should be given extra consideration is to divide countries based on whether they run a surplus or a deficit. More specifically, does a country run a current account surplus or a current account deficit and why should it matter? Why it matters whether countries have a current account surplus or deficit Countries with significant current account deficits tend to borrow heavily relative to the size of their economy, usually from foreign sources of capital. For many years, this wasn’t such a big issue due to the prevalence of very low interest rates in the U.S. This forced many to look at alternative places with higher yields. Many emerging markets offered such a destination. However, the Federal Reserve is widely expected to begin raising interest rates, which will make it more expensive to borrow. Monetary conditions have actually already tightened even though the policy of zero interest rates is technically not yet over. Capital outflows have picked up in a number of emerging markets as foreign capital is anticipating the next move by the Fed. In this environment where borrowing is increasingly problematic, countries with a current account surplus should be more resilient to higher interest rates than those with chronic deficits. The latter will have to make more adjustments to the existing structure of their economy than the former and this may cause a divergence in how countries perform going forward. Deficit countries do have a number of options when it comes to dealing with higher interest rates. For instance, they could try to reduce their imports and the need for hard currency to pay for these imports. Large reserves can also provide relief. Even so, surplus countries should have a much easier time as their transition period should be shorter and less complicated than those that have to fix or at least try to reduce their deficits. A major advantage for the former in comparison to the latter. Emerging markets ranked by surplus or deficit The table below lists 15 of the most prominent emerging markets, starting from those with the largest current account surplus to those with the biggest deficit. These countries combined make up 96.33 percent of EEM. Based on these numbers, Taiwan should have the least amount of trouble dealing with the Fed raising interest rates. South Africa is the one that looks the most vulnerable as of right now. Mexico may have a bigger deficit, but it’s also a bigger economy. Country GDP Current account surplus/deficit (USD) Taiwan 489B 19.67B South Korea 1410B 10.61B Russia 1861B 5.4B Thailand 374B 1.56B Malaysia 327B 1.21B Philippines 285B 0.95B China 10360B 0.63B Turkey 800B 0.09B Poland 548B -0.96B Chile 258B -2.59B Indonesia 889B -4.01B Brazil 2346B -4.17B India 2067B -6.2B South Africa 350B -8.68B Mexico 1283B -8.86B How to position yourself with regard to emerging markets One drawback of an ETF such as EEM is that it can get dragged down by a few bad apples. Some countries may do very well within the basket, but their performance can get negated by other countries that are doing poorly. A possible solution to this issue would be to take out the bad apples and leave only the good ones. If someone agrees with the thesis that emerging markets with big deficits will have a harder time with higher interest rates, then it’s best to avoid these countries and stick with the ones that run sizable surpluses. The latter are much less likely to experience any setbacks resulting from changes in global monetary policies. As such, they’re more likely to outperform resulting in better returns.