An important question for any new, narrowly based ETF is whether it can deliver something new for investors in its sector.

In July,

I wrote about the then-new

Claymore/Clear Global Exchanges, Brokers and Asset Managers Index ETF


. In that first article I suggested that the one thing that might differentiate it from two other ETFs in the sector, the

iShares DJ US Broker-Dealers Index

(IAI) - Get Report

or the

KBW Capital Markets ETF

(KCE) - Get Report

, would be the newer fund's international exposure.

(I should note that I was skeptical of the five-year back-test of the fund, because many of the publicly traded exchanges in the fund at inception only listed in the last couple of years.)

Since EXB's listing, the market had an all-too memorable stress test that can be the basis for comparison for all sorts of products and sectors.

In its first three months of trading, I believe it has gone a long way toward proving its mettle. And as I predicted, foreign exposure has been the point of differentiation. Since the ETF's inception, one of its foreign holdings, the

Hong Kong Exchange

, has doubled in price going from slightly more than a 4% weight (so it was one of the big ones already) to slightly more than an 8% weighting.

The move in the Hong Kong Exchange has gone a long way to changing the mix of the fund. Its foreign exposure has risen to roughly 37% from 33% at inception, and the weighting of exchanges, as opposed to brokers and asset managers, has risen to roughly 38% from 33%.

The impact of the fund's declining allocation to domestic brokerages was evident when

Merrill Lynch


TheStreet Recommends

announced its writedown Wednesday; the brokerage firm fell 7%, but EXB was only down a fraction of 1% -- even less than the overall market.

You probably know the line about the gold rush days, that the people who got rich were the ones selling the shovels and panning equipment, not the miners. I believe this pertains to the public exchanges, too. The trading business is not going to require fewer derivatives or get less sophisticated in the future. There seems to be a visible path for growth in the number of transactions that benefits these stocks.

The flip side would obviously be that, what the Hong Kong Exchange has given in terms of EXB's performance, it can also take away. Some sort of bubble-burst in China would no doubt be felt in Hong Kong, and so Hong Kong Exchange should be expected to participate in a meltdown, if it happens, regardless of the fundamentals.

The financial services sector is the largest sector in the

S&P 500

and probably the most complicated, too. It is difficult for the market to go anywhere without this sector. The sector is also unique in that it gives a clear warning when problems are likely to come: an inverted yield curve. This is something I have been writing about for a couple of years. When short-term interest rates are higher than long-term interest rates, the best strategy is to underweight the sector.

Lenders make money by borrowing money at short-term rates and lending it out at higher rates, so an inverted yield curve threatens their profitability. It also makes it harder for them to access capital. The public exchanges offer access to a part of the financial services sector that does not directly rely on lending. The more people trade, the better, and transactions can increase regardless of how well banks can access capital.

The only time this doesn't hold true is during a real market meltdown, like at the start of this decade. This results in less participation in the market -- no one wants to trade when prices are falling so fast. Swoons like that have historically only come every few decades, but if the market ever cuts in half again, the exchanges could be crushed. By comparison, in a normal bear market the prices might get hit but the business can still thrive.

It Pays to Diversify
Foreign exposure has helped EXB outperform its peers

Click here for larger image.


As real as this threat is, there is a semiannual rebalancing of EXB that will cut the maximum weight of any one stock to 5%. So as well as a couple of the ETF's holdings have done, it will be trimming their weight, helping mitigate some of the risk.

EXB's exposure to the asset managers offers a long-term demographic play on the baby boomers, but the brokers, like Merrill,

Goldman Sachs

(GS) - Get Report


Morgan Stanley

(MS) - Get Report

are likely to be a drag on the ETF's performance until the yield curve normalizes.

At the time of publication, Nusbaum's clients were long IAI and KCE, although positions may change at any time.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback;

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