Frontier Middle East Markets ETF?

By Travis Johnson, Stock Gumshoe, September 2, 2008

There has been a flurry of ads from the several newsletters that specialize in ETF selection (ETFs are exchange traded funds, for those who might not know — they’re more or less like regular mutual funds, but are listed on a major exchange and traded throughout the day, and usually track an index), and many of those ads are focusing on one of the hottest markets in the world: The Middle East.

There are a couple of reasons for that:

1, the stock markets and companies of the Middle East and North Africa really are on fire, and have been for a couple years in most cases — this is thanks in part to high oil prices, of course.

2, the ETFs and mutual funds that focus on this part of the world are all very, very new, so they think you won’t have heard of them yet … which means they can tempt you with the promise of the name and hope that you really will believe that the ETF will remain mysteriously hidden from your view without their help.

Thanks to your friendly neighborhood Stock Gumshoe, and to the mighty powers of his Thinkolator, you needn’t worry about number 2.

Now, let me be clear before I let the cat out of the bag on this one — there are a lot of newsletters that focus on ETFs and on regular mutual funds, and they might indeed be helpful for some folks. It remains true that most people, professionals included, are pretty bad at picking stocks, particularly in the short run, and that some form of indexing will probably outperform the average or novice investor most of the time, and will outperform even the best professionals some of the time.

The mutual fund-picking newsletters generally practice market timing and sector timing techniques of one sort or another, trying to outperform the broad indexes by getting you in and out of the best sectors, countries, or divisions of the market. That’s not necessarily that much easier than picking stocks for the long haul, it all depends on what you need, want, or like … but my point, tortured though it is now, is that several of these newsletters are good, and the fact that they choose from a much smaller universe doesn’t mean that they’re inherently stupid. (Actually, depending on how you look at it, some of them have larger universes to consider if they go beyond ETFs — there are more mutual funds in the US than there are publicly listed stocks on the major exchanges, but the vast majority of those are high-cost, broker-sold, restricted to particular investors, or too terrible to begin to consider using them.)

Indeed, a few of these newsletters are among the best performing long term performers in the Hulbert rankings. That’s largely because they don’t pick stocks, so none of their picks are likely to fall by 50% in any given year (though that does occasionally happen with some narrow ETFs and funds) and they tend to have less volatile performance due to the forced diversification of an ETF or fund portfolio. Don’t get me wrong, there are plenty of these newsletters that underperform the market, too, they’re just not inherently worse than stock picking newsletters.

But I did have a specific ETF to look for here, and it was teased by the folks at Street Authority, yet another reasonably large financial newsletter publisher that’s just down the road from my home. OK, it’s a long road, but I could walk there without ever being more than a mile from a Starbucks. The newsletter is called the ETF Authority, and it’s edited by Nathan Slaughter, who signed the ad I received in my inbox today. It’ll cost you $397, a special “discount” from the normal price of twice that much (that might be a bit tough to take for a mutual fund newsletter for some folks, Hulbert doesn’t track many ETF pickers but the best performing mutual fund newsletters, like No Load Fund X or the Vanguard or Fidelity-specific advisers, are often significantly less expensive than that and few approach the $800 “normal” price).

What does the ad tell us, aside from the fact that it’s an ETF that focuses on the Middle East and North Africa?

They include this little snapshot of the fund:

PE Ratio: 12.8

Expense Ratio: .88%

Strategy: tracks a dividend-weighted index 100 stocks trading in Kuwait, Egypt, Qatar and several other Middle East markets.

´╗┐Top Five Holdings: Maroc Telecom (9.7%), Emirates NBD (4.2%), National Bank of Kuwait (3.8%), Mobile Telecom (3.4%), Arab Bank (3.0%).

So, all of that sounds somewhat interesting, and is enough to narrow it down to our specific ETF … but do they say anything else that might pique our little greed impulses?

There’s a lovely bar graph showing the annual returns of stocks in several of these countries — over 75% for both Bahrain and Oman, for example, so that tends to get one’s juices flowing.

They mention Dubai, in order to remind us that it’s not just about oil, that some of these countries are using that oil wealth to try to build vibrant, sustainable economies, along the way building ridiculous and attention-getting projects like the Burj Dubai (tallest building in the world for at least 15 minutes, under construction) or the Palm or Earth concrete island developments.

And here’s the last big of salesmanship for us:

“In short, countries throughout the Middle East are using a flood of oil revenues to diversify their economies, upgrade their infrastructure, enrich the lives of their citizens, increase per-capita income, and attract outside foreign investment capital — all of which bodes well for companies operating in the region….

“Like any asset class, the Middle East markets have their own unique risks to consider, and I wouldn’t be doing you any favors by skating over them. In this part of the world, armed conflicts and political turmoil are ever-present threats. Plus, these markets are still a step behind when it comes to regulatory oversight and accounting standards — the SEC isn’t there to look over anyone’s shoulder. Nevertheless, this is a classic case of the risks being far outweighed by the potential rewards.

“Thanks to the recent launch of several new ETFs, U.S. investors have access to some of these markets for the first time. And although these are relatively funds, many of them track well-established market indices.

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“With all this in mind, those interested in the frontier markets of the Middle East and beyond might want to begin with one of my top picks…

“This ETF Targets Strong Income Producers

“Reasons to Buy:

“Oil-rich nations of the Middle East are enjoying robust and diverse economic expansion. Stocks in this oasis should continue to surge.

“This ETF’s focus on established, dividend-paying companies should lend some security to this still precarious, but potentially lucrative region — and backtested data shows superior annual gains of +26.7% over the past three years.

“As I suspected last month, this ETF looks to be the “best of breed” among the frontier markets group thus far.”

So … any guesses out there in the audience? No?

It’s true that there are several new ETFs that specialize in the Middle East and North Africa … but this specific one is …

WisdomTree Middle East Dividend Fund (GULF)

This fund has been around for almost two months, which puts it in the same daycare class as its two major competitors, the PowerShares MENA ETF (PMNA) and the Market Vectors Gulf States Index (MES). All three are a little bit different — PMNA is the broader index, pulling in Egypt and a few other countries outside the Gulf States, the Gulf States Index ETF is much smaller and narrower in focus, and our pick for today, the Middle East Dividend Fund, is the odd bird of indexes.

Wisdom Tree has gotten a lot of attention over the past year for doing things a bit differently — the typical index ETF, like any old S&P 500 Index fund, uses company market cap to apportion money to each stock in the index. That means all Index funds are market-cap weighted, so that the biggest holdings in any S&P Index fund will be companies like Exxon Mobil, Microsoft, etc, in order of their size. Wisdom Tree uses fundamental metrics like dividends and earnings to weight their indexes, so the largest holdings will be those that they think are cheaper, or pay higher dividends, or match other metrics they’re searching for. The firm wisely brought on Jeremy Siegel as their strategy advisor, who aside from being a professor at Wharton is a Wall Street God, having written Stocks for the Long Run and made probably the most compelling case yet for dividends as a critical factor in investing success. You’ve probably seen him in their ads if you spend any time watching CNBC.

It is a compelling argument, and it has been back tested for impressive gains, but these funds are all quite new, so I have no idea how the strategy will do over the next decades, especially for areas like emerging and frontier markets, where it’s reasonable to ask whether the same old rules will apply.

So … there is a bundle of logic behind this, and, thanks to the strategy, there is a good yield — just like any other fund, this one will pass along the dividends to you, and