After Claymore’s February liquidation, investors have been turning a critical eye to the viability of lightly traded ETFs.
The PowerShares FTSE RAFI International Real Estate Portfolio (PRY) was launched on December 28, 2007, as PowerShares’ first international real estate ETF. PRY, however, was not the first fund to chart these waters. WisdomTree’s International Real Estate (NYSEARCA:DRW), launched in June of 2007, offers similar exposure with a different methodology. While DRW has traded an average of 34,700 shares per day in the past three months, PRY has averaged less than 10% of that, trading 1,600 per day over the same period. The fund currently ranks No. 60 in the PowerShares Momentum Tracker newsletter.
In the time since both launches, the ETF universe suffered a loss. On February 1, 2008, Claymore announced in a press release its intention to “liquidate several lightly followed ETFs” as a result of “a natural selection process when it comes to investment options.” While Darwin has yet to tap PowerShares, it remains important to look both ways before stepping into a fund with PRY’s trading volume.
PRY and its corresponding index are supposed to provide investors with an exposure to real estate in developed countries— other than the U.S.—that fulfill four criteria: book value, adjusted funds from operations, sales, and dividends. WisdomTree, on the other hand, uses a more numbers-based dividend weighting method. The subjective nature of determining PRY’s fundamentals, seemingly, is what might make PRY’s 0.75% fee larger than DRW’s 0.58%.
Despite differences in methodology, the focus of both PRY and DRW is much more specific than the average international fund sought out by investors. At the same time, however, there is certainly an appeal to the consumer, who has been battling the fallout from the U.S. real estate bubble. This internal turmoil has caused many U.S. investors to seek shelter beyond their borders, desiring to remain in real estate while avoiding areas where they have been burned.
Even though PRY and DRW share the same focus, not to mention the top holding and top three countries allocated, their methodologies dictate that the funds have key differences. DRW has 192 components, and the largest five holdings comprise 28.82% of the fund. Despite having fewer holdings, PRY’s 146 are arguably more balanced, with the largest five comprising only 23.89%.
While Australia, Hong Kong, and Japan are the three top country allocations for both funds, the percentages are again different. DRW has 30.48% in Australia, 28.72% in Hong Kong, and 10.05% in Japan. PRY has 20.97% in Australia, 19.42% in Japan, and 14.63% in Hong Kong.* This diversification and lower top-country concentration might take the edge off investors’ overnight exposure concerns. In addition to these allocations, it is important to remember that PRY’s fourth-largest country allocation, Canada at 10.31%, is excluded from DRW’s index altogether.*
DRW and PRY share top component Westfield Group, though it makes up 4% more of DRW than it does of PRY. Westfield Group’s [AU: WDC] stock price has decreased 23% from its high last October, despite increased revenue. This REIT giant, however, has managed to easily outperform the sector, which is down more than 30% from last June, while Westfield has only suffered a 10% loss.** When Westfield presented increased revenues in May, Quentin Velleley, an analyst at Citigroup, noted that “Westfield’s first quarter highlighted a repeat performance of Australian strength offsetting U.S. weakness.” If WDC remains a paradigm of this performance, these funds may offer some much needed relief for U.S. REIT holders.**
The year-to-date return for PRY is -13.53%, while DRW is down -14.16%. What these funds lack in total returns, they make up for in volatility. Since PRY’s December launch, DRW’s share price has fallen precipitously from 48.15 to 39.24 on June 11. Intraday trading in PRY has been marked with scarce volume and sharp swings: the 52-week high for the fund was 28.10, while it has traded as low as 20.61.** PRY’s volatility, coupled with a share price that has seen premiums as high as 3%, may be enough to scare off most investors.
Despite lower returns, or perhaps because of a lower fee, DRW’s three-month average trading volume is more than ten times that of PRY. Taking into account issues of timing, fees, and composition, investors have seemed more likely to turn to DRW than PRY. The question then becomes whether the lack of interest in PRY makes the fund more trouble than it’s worth, especially when a similar fund offers comparable exposure.
Lack of interest can sometimes cause lack of liquidity in the best-intentioned ETFs. The fewer people involved in the marketplace, the further the ETF can stray from NAV. This might cause a problem if an investor is looking to sell shares of an ETF in the open market and is forced to accept a serious discount due to a shortage of buyers.
For those interested in hedging ETF investments, PRY presents a problem typical of many international ETFs: the portfolio comprises companies that are responsive to news events that may take place outside of U.S. trading hours. With more than 50% of the components trading in Australia, Hong Kong, and Japan, shareholders have to burn the midnight oil, as well as commission dollars, to directly hedge the synthetic exposure to PRY’s components accumulated over the U.S.’s 9:30 a.m. to 4:00 p.m. trading day.
Although ETFs can be redeemed for shares of their underlying components, redemption can only take place in large share units, numbers far beyond the average investor’s holdings. PRY’s redemption unit is 100,000 shares, twice that of an average domestic fund, so the option of redemption for any shareholder, especially an average investor, provides little relief from the absence of liquidity.
By providing exposure to international real estate, narrowing that focus to developed countries, and excluding the U.S., PRY may simply be trying to do too many things at once. Combine this with the fact that another fund, DRW, offers the same focus with lower fees, and you have a recipe for illiquidity. PRY’s complicated nature may be turning off the investors who have been aggressively seeking out international funds while not providing liquidity for those who do.
* Source: Powershares.com /Wisdomtree.com
Period* Mkt. Return (%) +/- Index Return**
1 week -1.83 +0.90
1 month -11.67 -1.31
3 months -1.68 -6.61
YTD -14.49 -7.39
**Index: S&P 500 TR
Top Ten Holdings*
Westfield Group (Australia) 6.31%
Mitsui Fudosan Co. Ltd. 5.25%
Brookfield Asset Management 4.57%
Sumitomo Realty & Development 4.24%
Land Securities Group PLC 3.52%
Unibail-Rodamco S.A. 3.52%
Mitsubishi Estate Co. Ltd. 3.42%
Lend Lease Corp. Ltd. 3.11%
Sun Hung Kai Properties Ltd. 2.79%
Cheung Kong (Holdings) Ltd. 2.08%
*As of 6/13/08