Australian Financial Review, December 2007

A few weeks ago we introduced you to the iShare range – a new series of exchange traded funds from Barclays Global Investors. These, for the first time, allowed Australian investors to get direct exposure to international stock markets just by buying a share.

ETFs are like index funds, but listed. By buying just one stock, just like buying shares in Telstra or CBA, you get exposure to a whole market. The crop we looked at recently included ETFs that mirror global stocks, emerging market stocks, European, American and Japanese stocks, among others.

Now, there are another six, most of them focusing on individual Asian markets (plus one that covers US small cap stocks). It’s an interesting time to launch them: as much of the world appears to be heading into a slowdown, Asia is still going gangbusters, so the opportunity to get exposure to those markets is a welcome one.

Before we look at them in detail, a few general points about ETFs. Unlike a listed investment company (LIC) – which also gives you exposure to a whole portfolio through a single stock – these always reflect the market they represent. In other words, when you buy an ETF reflecting the S&P 500, it’s never going to trade at a discount or a premium to what the S&P 500 itself is doing.

The appeal of using one purchase to get a whole market is very clear – simplicity – but it’s also generally cheap. The new bunch has a management expense ratio of between 0.2 and 0.74%, depending on the market.

That’s much cheaper than a managed fund – but it’s crucial to realise that they aren’t managed funds. A fund manager earns his fee by picking the best stocks in a particular market and leaving aside the dross. An ETF gives you the rough with the smooth: it’s a cheap and efficient way of getting exposure but it is not discerning and gives you the whole of a market, its good and bad constituents.

Another point to consider is that there are many investment products that give you overall exposure to Asia. Investing at an individual country level is rarer, and it can be tricky from Australia to get a handle on the many and varied developments in Asian markets. Generally, investors start with a global product, then might take specific positions on individual regions; they’re unlikely to want to invest more than a small amount at the fringes on country-specific Asian products.

Let’s take a closer look at the new products:

MSCI Hong Kong (fee: 0.54%)

This holds the Hong Kong market. Naturally, in large part, that’s a China play: most China managed funds you might buy actual hold Chinese stocks listed in Hong Kong, which include H-shares (Chinese companies, Hong Kong listing); red chips (Hong Kong incorporated but with heavy mainland ownership and business focus); and plenty of Hong Kong companies who exist because of their business in China. However, the big H-shares don’t appear in this one, but in the China product below.

As of November 30, the largest holdings this gives you exposure to are Hong Kong Exchanges & Clearing (the stock exchange); the two vast empires of Hong Kong uber-businessman Li Ka-Shing, Cheung Kong Holdings and Hutchison Whampoa; other big properties groups like Sun Hung Kai and Hang Lung; the retailer Esprit; local (Hang Seng) and Chinese (Bank of China HK) listed banks; and the trading group Swire Pacific. All of these have at least some Chinese earnings.

Hong Kong’s impending doom has been forecast for years, whether because of China’s liberalisation or its regaining control of the city. 10 years on from the handover there’s been little reason for alarm commercially, and the market is still travelling well: up 19.3 per cent in the six months to September 30, for example.

FTSE/XINHUA CHINA 25 (Fee: 0.74%)

This is one of the most closely watched Chinese indices, holding 25 stocks that are available to international investors. Consequently these generally aren’t mainland Chinese listings (which foreigners by and large can’t participate in) but overseas listings, chiefly in Hong Kong.

The biggest exposures through this fund are China Mobile; two insurers, China Life and Ping An; three energy groups, Petrochina, China Shenhua Energy and CNOOC; and several banks, China Construction bank, Industrial & Commercial Bank of China and China Merchants Bank. These sectors – telecoms, financial services and energy – have been where the bulk of the landmark Chinese listings have been concentrated. 25 is clearly a small number of stocks to underpin an ETF (even concentrated mutual funds tend to hold more than that) but these are big, liquid companies and do represent the might of Chinese blue chips.

At 59.2% in the six months to September 30, this has performed fantastically. But, as everyone is asking, how much longer can this last?

MSCI SINGAPORE (Fee: 0.54%)

Singapore is buzzing at the moment: huge new casino and resort developments, a booming financial sector, property prices going through the roof, a Formula One next year. Singapore is too mature a market to offer wild China-like market performance (the MSCI Singapore index went up 9.53% in the six months to September 30) but it is a strong market. “We believe Singapore has a unique story that will pan out over the next two to three years,” says Melvyn Boey, research analyst at Merrill Lynch. “We think governmental policies on the island are transforming it from a manufacturing biased economy to one that is knowledge and service centric.” GDP growth is expected to be a more than healthy 6.9% in 2008.

The biggest constituents of the MSCI index are SingTel, the local telco; then the three banks, UOB, DBS and OCBC; and various other businesses such as property developer CapitaLand, the stock exchange (Singapore Exchange), Singapore Airlines and Singapore Press Holdings.

MSCI South Korea (Fee: 0.7%)

Korea is an interesting market, not really developing any more but with some emerging market characteristics, notably market choppiness. Lately that’s been working in investors’ favour: 23.23% performance of the index in the six months to September 30.

Korea has a few real landmark companies, and they all feature prominently in the index fund. Samsung Electronic, Korea’s marquis company and a constant winner of best-managed companies polls for the country in Asian financial magazines, accounts for over 13% of the index, followed by port operator POSCO and Korea’s leading bank, Kookmin, a mainstay of many Asian stock portfolios. Below that, weightings are much smaller, but you get exposure to things like heavy industry, automobiles, power and banks.

MSCI Taiwan (Fee: 0.7%)

Taiwan, for all its sabre-rattling with China, is very closely tied to the mainland. It is a key export destination, and despite the difficulties of conducting trade between the two (there are still no direct flights, for example, with most people having to go via Hong Kong) a huge part of Taiwan’s population and business world is engaged with the mainland.

Taiwan is certainly impeded economically by restrictions on China trade, particularly in its financial centre, but this may change following Taiwan’s forthcoming elections, since either candidate is likely to take a softer stance to China then current premier Chen Shui-bian has done. If that leads to relaxations, it should be to the benefit of Taiwan, and its stock market.

Taiwan is dominated by its electronics industry. Taiwan Semiconductor is to Taiwan what Samsung Electronics is to Korea – a world leader, widely admired, and dominant in the stock market. Other key holdings include Hon Hai Precision, Mediatek, AU Optronics and Asustek, all involved in semiconductors or consumer electronics. Other big constituents of the index include financials (Cathay Financial), plastics (Nan Ya Plastics, Formosa Plastics), steel and telecommunications companies.

Taiwan is doing fine, with 10.52% performance in the six months to September 30, but there is a feeling it could be doing better.

RUSSELL 2000 (Fee: 0.2%)

This is an index that tracks US small caps. Specifically, it tracks the smaller 2000 of the Russell 3000 Index. The idea of small cap investing is that, ideally, it gets you in to tomorrow’s superstars before all the price appreciation has happened; the corollary to that, of course, is that plenty of stocks never become anything of the sort, instead disappearing because their size makes them vulnerable to things beyond their control (new entrants, cost of materials, national recession). So it’s a different risk/reward profile to blue chips.

This is a very different beast to the other five products. While most of them have at least one stock accounting for 10 per cent of the index, the largest holdings in this one account for barely half of one per cent: Hologic, Exterran Holdings and CF Industries. These are hardly household names, but that’s the point.

In terms of sector allocation, the fund ends up with almost 21% in financial services, 17% in consumer discretionary, 14% each in technology and healthcare, and 10 per cent in materials and processing. One other distinction: this part of the market hasn’t been doing well, giving America’s broader economic travails, and is down 7.51% in the six months to September 30.