New ETFs for Asian Bonds and Small Caps

08/11/2011 9:30 am EST

Focus: GLOBAL

In late July, the SEC received paperwork seeking permission to launch an ETF offering exposure to so-called "dim sum bonds," which are bonds denominated in Chinese yuan but sold in Hong Kong, notes Robert Goldsborough of Morningstar ETFInvestor.

If launched, the proposed Market Vectors Dim Sum Bond ETF would be the latest entry in the marketplace of locally denominated, emerging-markets bond ETFs. It’s a field that has drawn considerable investor interest in recent months, as investors seek to benefit from potentially rising emerging-markets currencies.

Up to now, investors interested in Asian debt have been able to consider WisdomTree Emerging Markets Local Debt (ELD) and Market Vectors Emerging Markets Local Currency Bond ETF (EMLC), along with the Asian-only WisdomTree Asia Local Debt (ALD) as well.

Recently, however, ETF providers have begun proposing more targeted vehicles, drawing up plans for funds that would hold yuan-denominated government and corporate debt. Now, Van Eck has filed for its own such offering, which would give US investors exposure to fixed-income securities from China only.

Because China restricts investors from investing in domestic Chinese debt, investors can gain that exposure through "dim sum bonds," which are named for the Chinese cuisine popular in Hong Kong but available all around the world. Because dim sum bonds are issued in Hong Kong, they help US investors get around those Chinese government restrictions.

The proposed dim sum bond ETF would hold yuan-denominated debt issued outside of mainland China (but largely issued in Hong Kong) by Chinese or non-Chinese issuers, including corporations, governments, and government and supranational agencies. Debt obligations could be either unrated or rated, and if the debt is rated, it would be permitted to be either investment grade or below investment grade.

The proposed ETF would use a sampling methodology, allowing it to purchase a portion of the bonds in the index with the same risk and return characteristics of the entire index. Van Eck did not detail a ticker symbol or an expense ratio for the proposed ETF.

WisdomTree Files for Asia Small-Cap and Germany Hedged Equity ETFs
Also, WisdomTree submitted paperwork with the SEC seeking approval to bring to market two foreign-themed ETFs: one that would be devoted to small-cap companies in developing Asian nations, and one that would hold protect investors in German companies who have concerns about the robustness of the euro.

The proposed WisdomTree Asia Small Cap Fund would track a WisdomTree-managed index of small-cap companies in the emerging Asia region.

The proposed fund would follow a sampling strategy, meaning that it would not hold all of the companies in the index, but instead a representative sampling whose risk and return characteristics closely resemble the characteristics of the index as a whole. Also, the ETF would follow a modified dividend-weighting scheme.

Notably, the proposed ETF would not hold Japanese companies. It would, however, hold China H-Shares firms, which trade in Hong Kong and are denominated in Hong Kong dollars.

Other countries and regions that would be represented in the proposed ETF include Hong Kong, Taiwan, Malaysia, Thailand, Indonesia, Singapore, Korea, India, and the Philippines. The proposed fund in theory would offer investors the best way to tap into the rapidly growing domestic economies in those countries, since smaller-cap companies generally have a higher portion of their sales locally.

Meanwhile, the proposed WisdomTree Germany Hedged Equity Fund would track a WisdomTree-run index of German companies, and would seek to isolate the performance of Germany companies attributable solely to stock-price movements.

As such, the proposed ETF would seek to neutralize exposure to currency fluctuations of the value of the euro relative to the US dollar. It would do so by selling the applicable foreign currency forward at the one-month forward rate.

That would mean that, for example, during a period when the euro is weakening relative to the greenback, this ETF would outperform an identical unhedged ETF.

The proposed fund also would employ a sampling strategy to generate results comparable to those of its benchmark. It also would be dividend-weighted, which means that unlike market capitalization-weighted ETFs, this proposed ETF would be weighted based on regular cash dividends paid.

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