Three Exotic ETFs

Whether you want to back green energy, benefit from emerging market bonds or avoid investing in banks, there's an ETF out there for you…

Exchange-traded funds (ETFs) are growing in popularity, and with good reason.

As diversified funds, they enable you to get the same broad exposure to the stock market that a traditional unit trust offers -- without the cost and potential underperformance of the latter's well-paid managers.

And as passive index followers, ETFs do the same job as index tracking funds -- but with the advantage that they are bought and sold on the stock market like any other shares.

This appealing mix has seen the total value of ETFs listed in London multiply 26 times since the turn of the century, up from £1.3 billion in 2001 to £34.7 billion in 2008.

200 ETFs are now available via the London Stock Exchange. That might seem a lot, but it's dwarfed by choice in the US, where over 750 ETFs are listed.

Have it your way

For all this variety, the most heavily traded ETF in terms of value is the iShares FTSE 100, which is a vanilla FTSE 100 tracker fund.

Yet new ETFs are regularly being launched to offer us the chance to back our views on a particular region, country or market sector without the risk of betting on individual company shares.

As a flavour of what's out there, here are three unusual ETFs from Barclays' iShares range that offer something completely different.

Note that the underlying portfolios of these ETFs are US-dollar-denominated, which means your returns will be affected by changes in the pound/dollar exchange rate.

Back foreign governments

JP Morgan $ Emerging Markets Bond Fund

Ticker LSE: IEMB

Price £57.73

Expense ratio 0.45%

Redemption Yield 7.09%

Fancy putting your money into Russian, Brazilian, Malaysian and Turkish government bonds?

While S&P has put the UK's debt on notice and some even fret over the mighty US Treasury market, emerging countries are enjoying more favourable press, with pundits pointing to their strong public finances and asset rich economies.

Yet the yields of emerging market bonds are still much higher than the government bonds of developed countries, due to their perceived greater riskiness.

If this sounds like a good balance of risk and reward to you, then check out the iShares JPMorgan $ Emerging Markets Bond Fund, which enables you to invest in just what it says on the tin.

Top 10 Holdings

The clean and green scene

S&P Global Clean Energy

Ticker (LSE: INRG)

Price £8.37

Expense ratio 0.65%

Distribution Yield 0.39%

The global economic slump might have poured cold water on talk of 'Peak Oil' for now, but global warming hasn't gone away. With even the U.S. now signing up to reductions in emissions, some speculate that green technology will one sector that leads any new bull market.

If you fancy putting more money into wind turbines and solar cell manufacturers, you could consider the iShares S&P Global Clean Energy ETF.

Be warned, the investment may be good for the planet and your wallet but it could give your nerves a rocky ride in the short-term -- the ETF is down 60% over the past year.

Top 10 Holdings

Shari'ah principles to the fore

MSCI World Islamic

Ticker (LSE: ISWD)

Price £10.67

Expense ratio 0.6%

Distribution Yield 1. 39%

I've included this ETF to demonstrate the importance of drilling down to discover what your ETF is actually holding, as your knee-jerk presumptions can be pretty wide of the mark.

I don't know about you, but when I read that…

"The MSCI World Islamic index is based on the MSCI World index, and is constructed by screening the constituents of the MSCI World index for compliance with Shari'ah investment principles"

…I didn't expect to see it holding the companies below.

That reflects my ignorance, of course, rather than any criticism of the MSCI World Islamic ETF. On reflection I'd guess its main point of differentiation would be the exclusion of financial companies.

Too much of a good thing?

Not everyone thinks this profusion of ETF choices is a good thing.

John Bogle, who pretty much invented index funds, has warned that the supply of more exotic ETFs risks distracting investors from the basic advantage of tracking the broad stock market.

Chasing hot sectors via ETFs can encourage over-trading and poor returns, just like with conventional unit trusts. And while ETFs are much cheaper to move money in and out of than traditional funds, there are still dealing costs to pay -- as well as the risk of buying high and selling low that always dogs active share trading.

Finally, more specialised ETFs have higher total expense ratios, and so are costlier to hold.

My own view is that provided you're away of these potential pitfalls, the broadening ETF market is to be welcomed.

Being in the right sector at the right time can be at least as valuable as investing in the right companies -- think of technology in the mid-1990s, or miners a couple of years back.

If ETFs enable us to ride on the back of a particular sector without the risk of a specific company blowing up, then that extra flexibility can only be a good thing.

More on ETFs and funds:

• The Rise And Rise Of ETFs
• Danger! Unexploded ETF
• When To Ditch Index Trackers