Want to get in on stocks in Africa? Play roulette with the Russian ruble? You can, using some of the more exotic exchange-traded funds.
An asset class that began as a ho-hum index-tracking tool more than 15 years ago has evolved into a playground for index designers, offering easy access to esoteric corners of the market and far-flung reaches of the globe. While exotic funds shouldn't make up the core of any portfolio, surprising inventiveness at the fringes of the ETF world is providing investors exciting new options (and possibly profits) that were unavailable just a few years ago.
"Retail investors can create their own hedge fund with products that are out there without having to get into a hedge fund, or pay high fees, or deal with illiquidity. All the products are there for the first time in their lives. It's a wonderful thing," says David Fry, founder of the online newsletter ETF Digest.
Here's a field guide to ETF exotica:
Countries and currencies. ETFs tracking national indexes or broad baskets of well-known local stocks in countries from Brazil to Belgium give U.S. investors new ways to diversify their portfolios. Investors with a tolerance for risk can use country funds to get in on growth around the globe. For example, the popular iShares FTSE/Xinhua China 25 fund can be used to make a long-term bet on a fast-growing economy or for quick trades on market-moving news (last month's announcement of a $586 billion stimulus package in China sent the fund up nearly 4 percent). There are funds for South Africa, Singapore, and Austria, and new ETFs are on the way for Argentina, Colombia, Egypt, Peru, and the Philippines. Funds track world currencies from the Russian ruble to the Mexican peso, and risky "frontier" markets are opening, too, with new ETFs tracking stocks in the Middle East and Africa. One tip: When it comes to national or regional funds, check out their holdings. They are often skewed toward specific countries or sectors. The Chinese fund mentioned above, for example, is nearly 40 percent bank stocks.
Sectors, stocks, and houses. A whole host of highly specific ETFs trade in plain-vanilla U.S. stocks. Solar, wind, and water companies all have their own funds, and trendy new ETFs for trading carbon credits and credit default swaps are in the works. Investors can already bet on the price of a gallon of gas using the United States Gasoline Fund, which tracks gasoline futures on the New York Mercantile Exchange, and soon they'll be able to invest in a fund tracking the direction of home prices. MacroMarkets is offering two funds designed to track the ups and downs of the S&P/Case-Shiller Composite-10 Home Price Index.
Heating oil, natural gas, and a host of other commodities have their own indexes, too. Funds tracking gold prices, agriculture companies, and mining stocks have been popular this year as well. "One of the great things ETFs have done is unlock the commodities space for retail [investors] and institutional advisers," says Benjamin Fulton, executive vice president of global product development at Invesco PowerShares.
Leveraging large. Other types of high-risk trading, specifically leveraging up (using borrowed capital to generate outsize returns), are being pushed to new limits. In the latest twist, ETFs from Direxion offer three-times leverage on indexes and sectors. That's right: If the index goes up a buck, you get three (and lose the same big chunk if it drops). "They strike me as a bit crazy" for average investors, says Matt Hougan, editor of IndexUniverse.com. The funds are best for short-term trades and need explanation, since volatility can eat up returns over time as the funds rebalance.
But as new funds continue to expand what ETFs can do, intrepid (sometimes foolhardy) investors can take heart that no matter how they want to trade, there's a fund somewhere that will let them do it.