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By Jason Stipp | 04-11-2011 05:16 PM

ETFs for the Corners of Your Portfolio

Morningstar's Paul Justice comments on the options that physical commodity, currency, volatility, and single-country ETFs have offered investors, and how these funds may be used in a portfolio.

Jason Stipp: I'm Jason Stipp for Morningstar.

It's ETF Investing Week on, and today we are talking about some of those corners of the market where ETFs go that not a lot of other investment types go.

Here with me to dig into some of those is Morningstar's Paul Justice. He's our director of North American research for ETFs.

Thanks for joining me, Paul.

Paul Justice: It's more exciting than Shark Week for me, so I am glad to be here.

Stipp: Well, we are certainly glad to have you.

There are some areas where ETFs have gone out and given people exposure that they really couldn't get otherwise before the advent of the ETF, or at least not very easily.

I wanted to talk about a few of those. The first one I think is one that a lot of investors are taking more interest in now, and ETFs have given them that access, is commodities. How are ETFs investing in commodities, and how is it being done now that it hasn't been done in the past?

Justice: Well, we have many more commodity funds in ETFs than we do in the open-end mutual fund structure, which is really interesting given how long those investments have been around--we didn't even deem that there was enough funds to create an entire category for those before.

But now with ETFs, we are getting targeted exposure in so many ways you can't access with mutual funds ... the common ones are broad basket indexes, which you could get a mutual fund, but now you get the targeted exposure, you get down to single types of commodities: oil, natural gas copper. We are talking about wheat, corn, just about anything that you could really do down at the mercantile exchanges themselves, you are really able to do in an ETF now.

Especially popular are the precious metal funds, think about the [SPDR] Gold Fund GLD, the fourth-largest holder of gold in the world at this point. That was a fund that wasn't around back in 2003. This has really changed the landscape of the way people access markets.

Stipp: So I know one of the things with that gold fund, for example, they actually hold the commodity instead of using the futures markets to gain access. Is the holding of the commodity something that's specific to some ETFs that we hadn't seen in other investment vehicles before?

Justice: It is, so you could get it say in a closed-end fund structure at some times, but why would you want to go out and pay say a significant premium to buy a metal when you know it's broadly traded and exchanging hands and is going to be stored in the vault just like the ETF.

If I look at a horrible fund right now, there is this Sprott Silver Trust, that's trading at a 20% premium to silver prices. To me that's absurd. You could go out and buy the silver ETF and actually get a fair price and get the same silver stored in a vault for you. So, I think that getting it through ETFs has been a great way to gain access to precious metals, where you are getting the actual spot price performance.

Stipp: So ... we are going to have more information on commodity ETFs on [Thursday], but certainly some areas where investors can go now they couldn't before.

Another area is currencies. ETFs have made available all different sorts of currency exposures. How would an investor use such an ETF?

Justice: Well, there are several ways. Obviously, a lot of people are using these for speculation. So, you think that the yen is going to get weaker relative to the dollar, you can trade that through an ETF. There are so many ETFs now that are linked up to pair trades between the U.S. dollar and some other currency.

So, if you want to speculate, that's one way you could do it, or if you do have a vested interest in some of those areas, and you want to hedge out that exposure, that's another great use for the ETF, because you don't have to go long the ETF; you can also short it to neutralize any exposure you have in your portfolio.

So, you can enhance volatility, you can reduce volatility, and you can buy funds that, if currency was your main concern, but you wanted exposure to those equities, you can pair them up together and really get that targeted exposure you are looking for. So, in that case, I think having this proliferation of product choices is a great thing for someone who is a bit more sophisticated.

Stipp: Another area--and I think you'll have to explain this a little bit to me--that ETFs have branched out and given people exposure to is volatility. What does it mean to invest in volatility?

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