How To Construct a BRIC-Tracking Portfolio

I have previously written about the tremendous projected growth of the emerging markets of Brazil, Russia, India, and China (see posts from January 2007 and May 2007). Rapid economic development in each of these countries is projected for decades to come. As I mentioned back in January 2007, Goldman Sachs published a report in 2003 on the BRIC countries and projected that the economies of these countries will grow much faster than any of the current developed markets (including the U.S., Japan, Germany, the U.K., Italy, and France) and the local currencies of the BRIC countries will appreciate some 100-300% against those of the developed markets.

There are popular relatively low-cost emerging markets ETFs currently being offered, such as the iShares MSCI Emerging Markets Index Fund (symbol: EEM), which tracks the MSCI Emerging Markets Free Index. Another popular emerging markets ETF is the Vanguard Emerging Markets ETF (symbol: VWO), which tracks a slightly different emerging markets index, MSCI Emerging Markets Select Index. Both the iShares and the Vanguard ETFs are a good way to invest in emerging markets. However, both invest only around 40% of their assets in the BRIC countries.

I have been waiting for some time for a good BRIC ETF to be introduced that invests only in the BRIC countries. So far, two BRIC ETFs are trading on the market. The oldest is the Claymore BRIC ETF (symbol: EEB), which tracks the Bank of New York's BRIC Select ADR Index, as I discussed back in January 2007. The other BRIC ETF is the SPDR S&P Bric 40 ETF (symbol: BIK), which was introduced in June 2007 and tracks the S&P BRIC 40 Index.

Although I am glad that BRIC ETFs are finally available, I do not like either of the currently available BRIC ETFs. According to ETFconnect, the Claymore ETF invests in the BRIC countries according to these allocations:

• India - 13.56%
• China - 35.79%
• Brazil - 45.88%
• Russia - ???? (possibly 4.77%)

The S&P BRIC ETF invests in the BRIC countries according to these allocations:

• India - 6.70%
• China - 40.05%
• Brazil - 26.75%
• Russia - 25.05%
  

I don't like either of these BRIC ETFs because they both over-allocate investments in certain BRIC countries at the expense of other investments in other BRIC countries. For example, I fail to see the logic behind the index tracked by the Claymore ETF investing less than 5% in Russia stocks, or the index tracked by the S&P BRIC ETF investing only about 6.7% of assets in Indian stocks.

I would prefer to see a BRIC ETF that invests about 25% of assets in each of the BRIC countries. Country-specific ETFs and ETNs are available for small investors to create their own relatively low-cost BRIC-tracking portfolio. I personally would invest according to the following allocation:

• Brazil - 25% - iShares MSCI Brazil Index Fund (symbol: EWZ)
• Russia - 25% - Market Vectors TR Russia ETF (symbol: RSX)
• India - 25% - iPath MSCI India Index ETN (symbol: INP)
• China - 25% - iShares FTSE/Xinhua China 25 Index Fund (symbol: FXI)
  

In order to minimize transaction costs, I would invest via a low-cost brokerage, such as Ameritrade Izone, which only charges $5 per trade. I would also purchase a minimum of $1500-2000 of each security at the time I create the portfolio, and I would rebalance once per year. Because of the inherent volatility of emerging markets, I would probably limit a BRIC investment to 5-10% of my overall portfolio.

How to Collect Pre-1982 Pennies and Nickels

I have previously mentioned that I am collecting nickel coins and pre-1982 pennies because their intrinsic melt values (i.e., the commodity value of the metals comprising the coins) exceed their respective face value. According to coinflation.com, as of the market close on August 10, 2007, a U.S. nickel coin has a melt value of 6.34 cents (i.e., 26.88% above face value) and a pre-1982 penny has a melt value of about 2.42 cents (i.e., 142% above face value).

I am saving nickels and pre-1982 for their commodity value and because I passively enjoy coin collecting. The odds are that I'll never make that much money off collecting coins for their commodity value. To be perfectly honest, if I didn't enjoy collecting coins, this would probably be a waste of time.

I have seen people attempting to sell pre-1982 pennies for prices well above face value (and even above the melt value). This seems like a total rip-off to me, given the fact that pre-1982 pennies (and nickels) are still widely abundant in circulation. I know that many people are hoarding these coins, but don't forget that the U.S. Mint produced many billions of these coins that are still being used in commerce.

I personally save all of the nickels and pre-1982 pennies I receive in change, except for the ones that have gum on them or are extremely dirty. I also occasionally purchase rolls of pennies and nickels from bank branch offices. There is a bank branch office right across the street from where I live, so these rolls are easy to get.

I have purchase rolls of coins at face value from different bank branches and have never been hassled or charged a fee for doing so. I stopped purchasing rolls of pennies a long time ago because it was too much of a hassle to search through 50-penny rolls for pre-1982 pennies. However, every once in awhile I still purchase a few rolls of nickels. Once of the reasons why I like purchasing rolls of nickels is because I rarely receive and of the 2004 and 2005 "Westward Journey" commemorative nickels in circulation anymore. Luckily, however, I can usually find a few of the Westward Journey nickels in $2 rolls of nickels available at bank branches.

Vanguard Provides a New ETF That Tracks the MSCI EAFE Index

I have previously mentioned that the Morgan Stanley Capital International, Inc. Europe, Australasia Far East index (a.k.a., the MSCI EAFE index) is the "S&P 500" of foreign stocks. Until recently, the best ETF tracking the index was an iShares ETF (symbol: EFA). EFA is a core holding of my Hypothetical Model Long-Term Portfolio.

Accordingly to the iShares website, EFA currently has an expense ratio of about 0.35% and is the largest foreign stock ETF, with about $45 billion in net assets. Although 0.35% is a very low expense ratio, Vanguard has decided to undercut iShares with its own ETF tracking the same index. On July 26, 2007, the new Vanguard Europe Pacific ETF (symbol: VEA) began trading on the American stock exchange. VEA tracks the MSCI EAFE index and has an expense ratio capped at 0.15%.

Vanguard's new offering is welcome by investors and should sell quite well. I look favorably upon the ever-decreasing expense ratios of index-tracking ETFs.

July 2007 Returns For My Model Long-Term Portfolio

My Hypothetical Model Portfolio performed very poorly during July as the overall market swooned. As of the market close on July 31, 2007, the Hypothetical Model Portfolio was down $5,560.57, or about 3.55% during July. July 2007 was the worst month for the Hypothetical Model Portfolio since last May, 2006 when the Hypothetical Model Portfolio dropped 4.92%. Despite the awful July results, the Hypothetical Model Portfolio is still up about $5432 in 2007, a gain of 3.73%, as shown on the table below (click for a larger image of the table). Morever, the Hypothetical Model Portfolio is still outperforming the 3.58% return of the benchmark Vanguard S&P 500 Index fund (VFINX).

Financials experienced their second consecutive awful month, with the SPDR Financial components ETF (XLF) plummeting 9.07% and the iShares Dow Jones U.S. Select Dividend Index Fund (DVY) dropping 5.02%. Financials are still performing poorly due to the overhang from problems in the subprime lending market. Another poor performer with a large amount of financial exposure was the Vanguard Small Cap Value Index (VISVX), which dropped 7.21%. Other small cap issues also underperformed, resulting in the Vanguard Small Cap Index mutual fund (NAESX) dropping 5.76% during the month.

The only moderately impressive returns were registered by the iShares Emerging Markets ETF (EEM), which rose 0.70%, the Templeton Russia closed-end fund (TRF), which rose 0.46%, and the Nasdaq 100 ETF (QQQQ), which only fell by 0.07% in a weak market. This marks the second consective month during which TRF has registered a gain, following five months of declines from January - May 2007.

As of the end of July, two of the portfolio holdings are up in double digits so far in 2007 - EEM, which is up just over 16%, and QQQQ, which is up just over 10%. The performance of QQQQ has really surprised me, as I had not anticipated tech stocks to outperform this year.

Two of the holdings in my Hypothetical Model Portfolio paid dividends in July. As I mentioned in a previous post, the dividends from mutual fund holdings are reinvested, but the dividends from ETFs or a closed end fund (i.e., the Templeton Russia closed-end fund (TRF)) are not reinvested - instead, they will accumulate as "CASH" on the performance table below until at least $100 has accrued, at which point that money will be reinvested in one of the mutual fund holdings. The reason I am doing this is because the index mutual funds in this portfolio do not charge a transaction fee for reinvesting dividends. To reinvent dividends for any of the ETFs or TRF, on the other hand, would cause me to incur transaction fees for the trading commissions.

QQQQ paid a dividend of $0.037/share (a total of $7.76) on July 31st, which was moved to "CASH" on the table shown below. DVY paid a dividend of $0.58298 on July 5th (a total of $58.29), which was also moved to "CASH" on the table shown below.

The stock market's performance recently is somewhat disconcerting. However, I do not see any cause for alarm. The pullback during May and June 2006 was far worse than this one, and everything turned out well by the end of 2006. I think we are merely experiencing a correction right now. Corrections are absolutely necessary to maintain an orderly market with manageable levels of risk.

*The Hypothetical Model Portfolio was created with an investment of $100,000 in securities as of the closing values on December 30, 2005 and an additional $25,000 was invested n securities as of the closing values on December 29, 2006. The reason why the total cost in the chart is greater than $125,000 is because the total cost accounts for the value of distributions reinvested into the mutual funds in the portfolio.

June 2007 Returns

June 2007 Returns For My Model Long-Term Portfolio

My Hypothetical Model Portfolio registered a negative return during June 2007. As of the market close on June 29, 2006, the Hypothetical Model Portfolio was down $1682.12, or about 1.06% during June. However, due to strong results earlier in the year, the Hypothetical Model Portfolio is still up about $10,992 in 2007, a gain of 7.56%, as shown on the table below (click for a larger image of the table). The Model Portfolio is still outperforming the 6.91% return of the benchmark Vanguard S&P 500 Index fund (VFINX).

Foreign holdings were the best performers, led by the 3.82% increase in the iShares Emerging Markets ETF (EEM) and the 2.96% gain in the Templeton Russia closed-end fund (TRF). June was the first month since December 2006 during which TRF has posted a gain. Perhaps the premium compression of TRF is finally over.

Financials were the worst portfolio performers during June, with the SPDR Financial components ETF (XLF) dropping 4.00% and the iShares Dow Jones U.S. Select Dividend Index Fund (DVY) dropping 3.99%. Financials performed poorly due to the overhang from problems in the subprime lending market. Another poor performer during June was the Vanguard Small Cap Value Index (VISVX), which dropped 2.51%. VISVX has a fairly large exposure to financial stocks and is now paying the price for it.

Three of the holdings in my Hypothetical Model Portfolio paid dividends in June. As I mentioned in a previous post, the dividends from mutual fund holdings are reinvested, but the dividends from ETFs or a closed end fund (i.e., the Templeton Russia closed-end fund (TRF)) are not reinvested- they will accumulate as "CASH" on the performance table below until at least $100 has accrued, at which point that money will be reinvested in one of the mutual fund holdings. The reason I am doing this is because the index mutual funds in this portfolio do not charge a transaction fee for reinvesting dividends. To reinvent dividends for any of the ETFs or TRF, on the other hand, would cause me to incur transaction fees for the trading commissions.

The Vanguard Index 500 mutual fund (VFINX) paid a dividend of $0.57/share (a total of $139.82), which was reinvested on June 22nd to purchase an additional 1.011 shares at a price of $138.82/share. TRF paid a long-term capital gain of $3.9272 on June 19th (a total of $251.34), which was moved to "CASH" on the table shown below. Finally, the S&P 500 Financial components ETF (XLF) paid a dividend of $0.204 on June 27th (a total of $19.98), which was moved to CASH.

As of June 29, 2007, there was a total of $347.45 in CASH. Because this amount was greater than $100, I reinvested this money in the Vanguard mutual fund holdings that lagged my target allocation by the largest amount. In this case, VISVX and VFINX were the only two Vanguard mutual fund holdings of which less than the target allocation amounts were held as of June 29th. Accordingly, on the 29th, $200 from CASH was re-invested in VISVX to purcash 11.179 shares at $17.89/share, and $147.45 was re-invested in VFINX to purchase 1.065 shares at $138.43/share. I put more into VISVX than into VFINX because VISVX trailed its target allocation by a larger amount than VFINX. These re-investments are indicated on the June chart below.

*The Hypothetical Model Portfolio was created with an investment of $100,000 in securities as of the closing values on December 30, 2005 and an additional $25,000 was invested n securities as of the closing values on December 29, 2006. The reason why the total cost in the chart is greater than $125,000 is because the total cost accounts for the value of distributions reinvested into the mutual funds in the portfolio.

May 2007 Returns

May 2007 Returns For My Model Long-Term Portfolio

My Hypothetical Model Portfolio performed very well during May, generating its largest dollar increase since January 2006 and the largest return, on a percentage basis, since October 2006, matching the 3.47% return achieved during April 2007. As of the market close on May 31, 2007, the Hypothetical Model Portfolio* closed up by $5,299.73 during May. The Hypothetical Model Portfolio is now up $12,674 in 2007, a gain of 8.71%, as shown on the table below (click for a larger image of the table).

All of my holdings were up except for the Templeton Russia closed-end fund (TRF), which had its fifth consecutive monthly drop in value due primarily to its ongoing premium compression, as I have discussed previously. The other nine holdings in the Model Portfolio all rose, led by the 4.93% return of the iShares Emerging Markets ETF (EEM) , the 4.41% return of the Vanguard Small Cap Index mutual fund (NAESX), and the 4.34% return of the Vanguard Midcap Index mutual fund (VIMSX). Financials lagged slightly during May, with iShares Dow Jones U.S. Select Dividend Index Fund (DVY) rising only 1.97% and the SPDR Financial components ETF (XLF) rising 2.40%.

Through the end of May, the Model Portfolio is up 8.71%, slightly trailing the 8.74% return of the Vanguard Index 500 mutual fund (VFINX). Four of the holdings are up over 11% so far this year. VIMSX is the biggest winner so far, having risen 13.12% in 2007, EEM has risen 11.06%, the Vanguard Developed Markets Index mutual fund (VDMIX) has risen 11.03%, and NAESX has risen 11.02%. The only negative performer so far has been the 2006 portfolio leader, TRF, which is now down a huge 21.25% in 2007.

None of the holdings paid dividends during May. However, QQQQ paid a dividend during April (on April 30, 2007) that I inadvertantly neglected to mention during my summary of the April results. The QQQQ dividend was $0.027/share, a total of $5.67. This dividend is listed in the chart below and was added to the CASH position. As I mentioned in a previous post, the dividends from mutual fund holdings are reinvested, but the dividends from ETFs or TRF are not reinvested- they will accumulate as "CASH" on the performance table below until at least $100 has accrued, at which point that money will be reinvested in one of the mutual fund holdings. The reason I am doing this is because the index mutual funds in this portfolio do not charge a transaction fee for reinvesting dividends. To reinvent dividends for any of the ETFs or TRF, on the other hand, would cause me to incur transaction fees for the trading commissions.

As of May 31, 2007, the premium on TRF is still a relatively low 6.18%, down from the typical double digit premium of the past few years. I still suspect that TRF's premium compression is pretty much over and expect TRF to start outperforming other holdings in the Hypothetical Model Portfolio just like it did during the last few months of 2006.


*The Hypothetical Model Portfolio was created with an investment of $100,000 in securities as of the closing values on December 30, 2005 and an additional $25,000 was invested n securities as of the closing values on December 29, 2006. The reason why the total cost in the chart is greater than $125,000 is because the total cost accounts for the value of distributions reinvested into the mutual funds in the portfolio.

April 2007 Returns