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Country-Specific ETFs: An Efficient Approach to Global Asset Allocation - Essay Example

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index-tracking funds with the tradability of listed shares, at the same time overcoming the main drawbacks of these two investment options for investors. Unlike trading in other open or closed-end country funds trading in country specific ETFs offers investors four additional benefits…
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Country-Specific ETFs: An Efficient Approach to Global Asset Allocation
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___________ ____________ ____March 2006 Country-Specific ETFs: An Efficient Approach to Global Asset Allocation Introduction Exchange-traded funds (ETFs) are "hybrid" mutual funds that combine the coverage of
index-tracking funds with the tradability of listed shares, at the same time overcoming the main drawbacks of these two investment options for investors. Unlike trading in other open or closed-end country funds trading in country specific ETFs offers investors four additional benefits. Open-end funds, only trade at 4.00pm NAV (net asset value) and closed-end funds trade continuously throughout the day with the condition that they can be sold short only on an uptick. ETFs, on the other hand, trade on a continuous basis and can be short sold on downtick. They can therefore be continuously sold short at any time during the trading day enabling liquidation or assumption of short positions at will, needed generally in down markets.Continuos trading and short selling lead to efficiency gains in trading in ETFs when compared to trading in open or closed-end country funds.ETF country specific funds are tax efficient. They are created in kind and redeemed in kind. ETFs shares are bought by market participants by depositing with the fund the index constituents. They are redeemed by investors getting underlying high unrealized capital gain stocks with the fund retaining low unrealized gain stocks. Thus ETF reduces capital gains tax liability as it would not be called upon to sell high capital gain stocks and incur capital gains tax. Open or closed end funds, on the contrary, redeem in cash and may have to sell high capital gains stocks in order to meet rushed redemption requirements and may end up paying capital gains tax on realized capital gains. ETF investors can exchange their ETF shares and receive in kind the underlying shares, or even sell their ETF shares on the stock exchange without getting into selling the underlying shares. This circumvents capital gains tax liability for all investors. For large institutional investors, the ETF's in-kind creation and redemption mechanism softens the market impact which otherwise can be telling when large parcels are traded on market.
Third, country-specific ETFs have more tracking precision as compared to conventional closed-end funds because creation and redemption of ETF shares frequently forces arbitrageurs to ensure close tracking and transparency in respect of underlying stocks in the fund. Fourthly, empirical studies have surmised that country-specific ETFs are cheaper than closed-end country funds with low expense ratios which can go as low as less than half of those experienced by other country closed-end funds.
Generally, country specific ETFs are passively managed and re-balancing is used to keep the investment portfolio closely in line with the relevant index (ETFs, like other index funds, essentially self re-balance, with portfolio changes balancing any corresponding change in the index constituents). ETFs also do not serve as part of market-timing strategies; therefore, no cash buffers are required and their holdings are not changed during, or in anticipation of, market downturns. The latter avoids the cash drag effect normally associated with funds who keep cash to take care of redemptions. By diversifying internationally using country specific EFT funds, we eliminate country-specific risk and consequently enhance mean variance efficiency and returns (Miffre, 2004).
Works Cited
Miffre, Jolle .2004." Country-Specific ETFs: An Efficient Approach to Global Asset Allocation". Cass Business School. London. Read More
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