Here’s our latest investing advice on 2 popular ETFs

When you join my Inner Circle service, you get my investing advice on your own personal investment questions, plus you get to see what other Inner Circle members have asked, along with our answers.

So you can get a sense of how our service works, and how our investing advice might help your portfolio, I’d like to share two recent member questions about exchange-traded funds (ETFs).

Q: Pat, What’s your investing advice on iShares MSCI Brazil Index Fund?

A: iShares MSCI Brazil Index Fund, $73.54, symbol EWZ on New York (Shares outstanding: 150.2 million; Market cap: $11.0 billion), is an ETF that is designed to track the MSCI Brazil Index. The index aims to capture 85% of the total market capitalization of the Brazilian stock market. The remaining 15% is unavailable for investment, partly because of limitations on foreign ownership.

The ETF’s top holdings are Petrobras preferred shares (energy), 12.5%; Petrobras common shares, 10.2%; Cia Vale do Rio Doce (mining) preferred shares, 9.4%; Cia Vale do Rio Doce common shares, 7.0%; Itau Unibanco Multiplo SA (banking), 7.8%; Banco Bradesco preferred shares (banking), 4.7%; Cia de Bebidas das Americas preferred shares (beer and other beverages), 3.2%; Cia Siderurgica Nacional SA (steel), 3.0%; Gerdau SA (steel), 2.4%; and OGX Petroleo e Gas Patricipa (energy), 2.4%.

The fund’s industry breakdown is as follows: Materials, 28.5%; Energy, 25.9%; Financials, 19.5%; Consumer Staples, 7.9%; Utilities, 7.0%; Telecommunication Services, 4.0%; Consumer Discretionary, 2.4%; Information Technology, 2.1%; and Industrials, 2.0%.

iShares MSCI Brazil Index Fund was launched on July 10, 2000. The ETF’s expense ratio is 0.63%.

The fund is up 136.2% from its March 2009 low of $31.14. That’s mainly because cuts to interest rates and taxes, as well as government stimulus spending, are boosting the Brazilian economy. These measures have helped Brazil’s currency, the real, rise sharply against the U.S. dollar over the last year. That’s the biggest gain of the world’s 16 major currencies. As well, the Brazilian Bovespa stock market index has outperformed all of the world’s 10 largest stock markets, except China’s.

iShares MSCI Brazil Index Fund’s focus on the Resource sector and its concentration in certain stocks, such as Petrobras and Cia Vale do Rio Doce, adds risk. However, both these stocks are among the highest-quality Brazilian companies available for investors, and both serve growing markets for resources.

For example, Petrobras benefits from having a virtual energy monopoly in Brazil’s emerging economy. While the Brazilian government will let foreign oil companies help develop the country’s vast offshore oil fields, Petrobras will still be the lead operator, and will own at least 30% of all new wells.

Our investing advice: iShares MSCI Brazil Index Fund is a buy for aggressive investors.

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Q: Pat, I’ve read your comments on investing in bonds and the risk of inflation/rising interest rates. What’s your investing advice on the “inflation protection” offered by ETFs, such as iShares Barclays TIPS Bond Fund? Thanks.

A: Because of today’s low interest rates, our investing advice is that you should generally avoid investing in bonds. This is especially so in light of the rise in inflation that may come from high government spending and the expansion of the money supply. That rise in inflation will push up interest rates over time. This will hurt bonds, since their prices generally move in the opposite direction as interest rates.

A: iShares Barclays TIPS Bond ETF, $105.01, symbol TIP on New York (Units outstanding: 182.1 million; Market cap: $19.1 billion), invests in the Barclays Capital U.S. Treasury Inflation Protected Securities (TIPS) Index. There are 29 securities in the underlying index.

The fund began trading on New York in December 2003 at $101.84 per unit.

TIPS are a special type of U.S. Treasury note or bond that offers protection from inflation. Like other Treasuries, an inflation-indexed security pays interest every six months and returns the principal when the security matures. The difference is that the coupon (or interest) payments and underlying principal automatically increase to compensate for inflation as measured by the consumer price index.

The advantage of inflation-protected U.S government bonds is that the purchasing power of the holder’s investment and yield is guaranteed. TIPS provide real rates of return — that is, returns that exceed the rate of inflation. The disadvantage is that, because of this inflation-protection feature, TIPS offer lower yields.

In Canada, inflation-protected bonds are called “real return” bonds.

The fund’s annual management expense ratio is 0.20%. All of its 29 holdings are U.S. Treasury TIPS. The fund’s weighted average maturity is 9.12 years, and the weighted average coupon payment is 2.28% a year. The fund yields 2.73%.

With today’s low inflation and low interest rates, inflation-protected bonds are less appealing than they were in the 1970s, when inflation and interest rates were high. Inflation is likely to rise over the next few years. But TIPS have only been around since 1997, so they have never been through a period of high inflation. It remains to be seen if their inflation adjustment will offset a drop in the underlying value of the bonds the ETF holds when governments raise interest rates to control inflation.

We’re not overly attracted by Canadian real return bonds (or funds that invest in them), either. All they do is ensure a low return.

Our investing advice: We don’t recommend iShares Barclays TIPS Bond ETF.

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