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Should You Buy ETFs of ETFs?

PowerShares just launched three fund-of-funds ETFs, which means they're ETFs that own other ETFs:

The three are:

  • PowerShares Autonomic Growth NFA Global Asset Portfolio (PTO)
  • PowerShares Autonomic Balanced Growth NFA Global Asset Portfolio (PAO)
  • PowerShares Autonomic Balanced NFA Global Asset Portfolio (PCA)

The names are indistinguishable to me but PTO is the most aggressive at 90% equities and 10% other stuff (combo of fixed income, commodities and currencies). PAO is the middle of the road at 75% equities and 25% other. PCA is the most conservative at 60% equities and 40% other.

The three funds own different mixes of essentially the same ETFs (there are a couple of differences), and track indices recently created by New Frontier Advisors. They all target specific allocations which will be reallocated quarterly, but the prospectus allows for more frequent rebalancing to occur if something truly dramatic happens in the markets like, perhaps, a 1987-like crash.

All three funds charge 25 basis points plus the respective fees of each of the underlying funds within.

The equity allocation of all three is very intriguing, because all three favor foreign stocks over domestic; PTO 49% foreign to 41% domestic, PAO 39% to 36% and PCA 31% to 30%.

PowerShares Dynamic Developed International Opportunities Portfolio (PFA) is a favorite of New Frontier Advisers as it constitutes 22% of the aggressive PTO, 15% of the middle of the road PAO and 7% of the conservative PCA. PFA uses a qualitative screening process to sort through foreign stocks to find names that should outperform.

Because New Frontier Advisors' process for inclusion is proprietary, it isn't clear why PFA seems to be such an overwhelming favorite. PFA listed last July and has tracked very closely to iShares MSCI EAFE Fund (EFA). PFA's back test was phenomenal, which perhaps contributed to the decision.

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