This past week on RealMoney, Don Dion blogged about ETNs designed to track the VIX, Eastern Europe ETFs and Brazil.

VIX-Based ETN Correlations Are Skewed

Posted 10/5/2009 5:20 p.m. EDT

The iPath S&P 500 VIX Short-Term Futures Index ETN ( VXX) and iPath S&P 500 VIX Mid-Term Futures Index ETN ( VXN) didn't capture as much of last week's pop in the CBOE Volatility Index (a.k.a., VIX) as some traders may have liked.

Between Tuesday and Friday, the VIX gained nearly 20%, but VXX only gained about 8%, while VXZ managed just 4%. On the flip-side, today's loss cost the VIX nearly 7%, but VXX shed 4% and VXZ fell less than 2%.

One difficulty with the rolling futures contract is that the future never arrives.

Options and futures have two components to their value:
  1. the underlying value of the security or index; and
  2. the time value.
For example, if you have the option to buy a stock one year from now, there is a greater probability that the stock will rise or fall a given amount over the course of a year, as opposed to one week.

If you purchase a futures contract and hold it until just before expiration, the time value will decay to nothing, and you will be left with the underlying value. Since these contracts roll daily, however, the time value is constantly replenished. A change in time value can affect the NAV of these ETNs, but it will never be replaced by the underlying value.

The VXZ holds futures contracts on the VIX in the fourth-, fifth-, sixth- and seventh-month contract, dropping the fourth- and rolling into the new seventh-month contract each day.

The VXZ will never be as volatile as the VXX, since the VXX holds first- and second-month contracts, also using a daily roll strategy.
chart

Since the VIX is not an actual index, it can't be bought. Investors can achieve greater returns with greater risk via options or futures, however, because they can hold them until expiration.

The takeaway is that these ETNs may not be the best bet for individual investors. Those who understand how the VIX works and want to make a bet on market volatility can achieve better returns in the futures and options markets. Furthermore, any number of leveraged inverse ETFs are likely to outperform the VIX ETNs, since spikes in VIX are typically accompanied by selloffs in stocks.

There may be some investors who can make use of the VIX futures ETNs as part of complex portfolio strategies, but investors who are looking to make a one-way bet on a market selloff should try other products.

I previously named the VXX and VXZ pair as one of the 10 most dangerous ETFs.


Comparing Emerging Eastern Europe ETFs

Posted 10/5/2009 12:20 p.m. EDT

On Friday, iShares launched the newest member of its international ETF fund family. The iShares MSCI Emerging Markets Eastern Europe Index Fund ( ESR) is designed to track the MSCI Emerging Markets Eastern Europe Index. Companies represented on this index hail from four nations: Russia, Poland, Hungary and the Czech Republic.

Investors looking for access to emerging Eastern Europe through this fund should be aware that the ESR is heavily weighed in energy companies. Gazprom and Lukoil are the fund's top two holdings and make up over 35.5% of the fund's total assets. Other top holdings include Sberbank, Cez and Norilsk Nickel.

The ESR is not the first ETF to expose investors to Eastern European markets. SPDR S&P Emerging Europe ETF ( GUR) has been trading since March 2007 and tracks a basket of companies from the same four nations plus Turkey and a menial showing from the U.S. Once again, a huge percentage of the GUR is allocated to the same top energy companies in the area.

Although the two funds have similar holdings and sector allocations, The GUR's low expense ratio will likely stifle some of the added competition from the ESR's entrance. While the ESR charges investors over 0.70%, the GUR only carries a 0.59% fee. Furthermore, with 63% of the GUR's assets in Russia vs. 75% of the ESR's assets, the GUR offers more diversification.

Year-to-date for the period ending Oct. 5, The GUR has performed well. The fund is up nearly 61%.

In the end, however, these funds are more like a Russia ETF, such as Market Vectors Russia ( RSX), which has a 0.62% fee that makes it competitive with these funds, with some added diversification into Eastern Europe. Investors who want pure plays on Poland and other Eastern European countries will have to wait.


Brazil ETFs Recap

Posted 10/7/2009

On July 13, I named Market Vectors Brazil Small Cap ETF ( BRF) as the best of the Brazil ETFs. I followed up twice this week, as news of the Olympics and the big Santander IPO have drawn the world's attention to Brazil.

BRF is the best way to play these events because its holdings are positioned to benefit. Longer term, BRF is the ETF for a rising Brazil, whereas iShares Brazil's ( EWZ) commodity and energy heavy holdings will do well in a commodity boom, even if the broader Brazilian economy underperforms.

EWZ is the ETF of Brazil's past. It's a story we've seen all over the globe: resource-rich nations that fail to transition to a diversified economy. If Brazil fails again, as it did in the 1980s following the '70s resource boom, then EWZ should outperform. But if it succeeds, BRF will be the fund to own. It is the fund of the future for the country of the future.

Since I picked BRF in July, the fund is up 49.5%. Over the same period, EWZ gained 38.7%, and Wisdom Tree Dreyfus Brazilian Real ( BZF) added 14.2%.On July 13, I named Market Vectors Brazil Small Cap ETF ( BRF) as the best of the Brazil ETFs. I followed up twice this week, as news of the Olympics and the big Santander IPO have drawn the world's attention to Brazil.

BRF is the best way to play these events because its holdings are positioned to benefit. Longer term, BRF is the ETF for a rising Brazil, whereas iShares Brazil's ( EWZ) commodity and energy heavy holdings will do well in a commodity boom, even if the broader Brazilian economy underperforms.

EWZ is the ETF of Brazil's past. It's a story we've seen all over the globe: resource-rich nations that fail to transition to a diversified economy. If Brazil fails again, as it did in the 1980s following the '70s resource boom, then EWZ should outperform. But if it succeeds, BRF will be the fund to own. It is the fund of the future for the country of the future.

Since I picked BRF in July, the fund is up 49.5%. Over the same period, EWZ gained 38.7%, and Wisdom Tree Dreyfus Brazilian Real ( BZF) added 14.2%.
Don Dion is president and founder of Dion Money Management, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.

Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.