This is taken from TFN’s Smart Trading Action Alert video with Mike Burnick, editor of Global Market Investor

Laura Cadden: In the last few years, some of the most popular investment tools have been exchanged traded funds. ETFs are pool funds invested with a specific investment objective, for example, as tracker funds for the energy or gold sector or even for a specific geographical area. They first became available in the U.S. in 1993 and spread to Europe in 1999.

The number of ETFs listed on the European exchanges reached 412, with 119 new ETF listings in 2007 alone. Another 60 or so are expected to launch in the next couple of months.

But why would U.S. investors buy foreign ETFs when there are hundreds of ETFs to choose from right here at home? More importantly, what do you need to look for before you begin to invest in them?

My guest today is Mike Burnick, editor of Global Market Investor. Mike, you have been quite active in regard to global ETFs. What is the attraction to these over individual stocks?

Mike Burnick: That’s a great question. ETFs, as you pointed out, are relatively new in the grand scheme of things. Stocks have been around hundreds of years, and ETFs have only been around for about 20 or so. But I think the most attractive feature with ETFs is the tremendous diversification you get. I mean, a single exchange-traded fund may have anywhere from a few dozen up to several hundred or more companies in it, so you don’t get the headline risk that you often get from individual stocks.

That is, a particular company, let’s say AT&T, comes out with negative earnings or the chairman says the wrong thing on TV or in an investor meeting, and the stock could plunge overnight just because if some specific news event. Now, with exchange traded funds they’re very diversified, so you might have one or two stocks going down, but they entire basket tends to hold up a lot better, even in a down market. So there’s a very risk-enhancing feature.

The other key thing is ETFs today, there’s such a wide variety that cover different asset classes, everything from stocks to bonds, real estate. They cover commodities. There are even ETFs that follow currency, so you can invest in the Japanese yen or the euro using an ETF. They even cover exotic investments like private investments or hedge funds. So with ETFs you can build your own miniature hedge fund portfolio and manage it yourself with just a handful of trades.

Very easy to do; very low-cost; very efficient.

Tired of reading? Multi-task! And listen to this video as you plug away at your chores!

LC: It’s funny you would say a fund. Some pundits have compared ETFs to mutual funds lacking the management. What should people be leery of with investing in them? What kind of research should they be doing before they choose to invest in an ETF?

MB: Right. That’s a great point. As you pointed out, ETFs are they call passive investments. They typically just track whatever index they’re designed to follow and that’s it. But that’s actually an advantage from the point of view of many investors, because, as you know, in the industry, most actively managed mutual funds fail to beat their benchmark. On a year-in-year-out basis they always fall short.

Plus, of course, actively managed funds charge much higher management fees; typically one and a quarter, one and a half percent. With ETFs, the average expense ratio is less than one half of 1 percent, so they’re significantly cheaper. And if you’re a long-term investor, that obviously pays off over five or ten-year period of time. Paying two-thirds less in fees is really going to add up and compound for you.

But you’re right, you do have to do your homework when it comes to ETFs because, as I mentioned, there’s so many hundreds of portfolios available these days, both domestically and on overseas exchanges, that they’re not all made light. They’re not all created alike, if you will.

There are some I guess what you might call truth in labeling problems with some ETFs these days. There’s others that would have a particular name, but they don’t really tend to follow exactly what it says they do. For instance, there was a fund launched not to long ago – I think it was last year – that was supposed to track the Eastern European markets.

I won’t single it out by name, but if you look at the fund’s prospectus or the fact sheet, you’ll notice that about 85 to 90 percent of all the stockholdings in the ETFs are actually in Russia. So really, it should be called a Russia fund not an Eastern European fund. You don’t really get exposure to a lot of the dynamically growing emerging markets in Eastern Europe, like Poland or the Czech Republic. It’s mostly almost 100 percent Russia.

LC: Interesting. So what categories, do you think, are going to perform strongly?

MB: Well, I’m really excited about the relatively new class of ETFs that were launched just in the last few years that tracked commodities. As you know, commodities have been a red-hot investment over the last – really, over the last five or six years of this bull market. We’ve seen crude oil more than double; some of the industrial metals have more than tripled; gold is up above $950 an ounce.

And one of the most successful ETFs in terms of the assets under management is GLD, which tracks the price of physical gold. It’s done very, very well. I think commodities, going forward, are going to be a great place to go, but the key now is to zero in or take a rifle-shot approach to those specific commodities that are really poised to do best and deliver the best gains over the next few years.

Now, on the London Stock Exchange, there’s a company that listed a whole series of ETFs that cover everything in the commodities sector that you could imagine. Everything from aluminum to zinc, and everything in between. I’m really excited about these agricultural commodities.

LC: The metals exchange is what you’re describing, right?

MB: Exactly. Metals and agriculture, the soft commodities, they have them all on the London Stock Exchange. That’s really exciting. As a matter of fact, they just launched a new series of funds that actually allow you upside leverage to commodities as well as downside protection with these so-called inverse funds.

LC: No kidding? So with foreign ETFs, don’t you have the added risk of currency?

MB: That’s a great point. Of course, whenever you buy an ETF like the ones that I just mentioned, if they’re on the London Stock Exchange or trading in Tokyo, for instance, or Hong Kong, you are making a currency bet basically in that nation’s currency in many cases.

For instance, you can buy Japan ETF, all the ETFs in Japan that are traded in Tokyo pretty much are denominated in yen, but that can be a good because the yen has been picking up here recently over the last several months against the U.S. dollar. So you can actually make a currency bet and kind of compound your potential return with some of those offshore ETFs.

I’ll give you an example. Last year, for my global market investor portfolio, I recommended my subscribers buy an ETF listed in Germany on the Frankfurt Stock Exchange that tracks commodities, specifically the Rogers International Commodity Index traded over there. There wasn’t anything like that available in the U.S. at the time, and two things really attracted me to that particular portfolio. As you mentioned, you’ve got to do your homework.

I looked at the prospectus, and this particular ETF is very, very broadly diversified for a commodity ETF. It holds 36 different commodities in the fund, and no one commodity like oil or gold, the popular ones, no one commodity is over-weighted in Jim Rogers’ fund. The great thing there is you’ve got really a broad basket of diversification. You don’t have a commodity fund that really attracts the price of oil or really attracts the price of gold. This is more broad-based.

So No. 1 was really the way the fund was put together. But No. 2, if you remember last year, the U.S. dollar was in the midst of a freefall against the euro. The euro was gaining; the U.S. was falling almost by the day. So I figured this particular ETF traded in Frankfurt would be a great way for my subscribers to get sort of a bonus play on the currency at the same time as the upside in the agricultural, and it worked out really well that way.

The fund was actually up about 12 percent last year in local currency terms. That is, if you’re a German investor and you just walked down the street to the exchange and bought, you’re up 12 percent, which is not bad in last year’s turbulent market environment.

Not at all. But for you U.S. investors because the dollar depreciating against the euro, they actually made twice that. They made 24 percent return; my subscribers did in that fund last year, and that’s because, as I said, the currency gave you even a turbo-charge boost to your performance.

LC: What about markets that are pegged to the U.S. dollar though like Hong Kong? Do you think this is going to have a real negative impact on those kind of ETFs?

MB: That’s an interesting point. The Hong Kong dollar, as you know, is pegged to the U.S. dollar. So if you buy one of the ETFs in Hong Kong, there’s a little bit of currency fluctuation within the trading band, but it’s fairly tight, so you don’t get much currency appreciation.

But one of the reasons I like Hong Kong right now and have been recommending some of the ETFs there is because, of course, it’s the gateway to China. It’s the front door into China, and China’s economy has been really booming. Plus, the markets there sold off as they did pretty much around the world last year and early this year in January.

So now, some of these Hong Kong Stocks are 20 or 25 percent off the highs from last year, and yet, the economy there is still booming. Seven percent growth we’re seeing in Hong Kong itself.

Mainland China is growing more like 11 percent annually. I mean, it’s just substantial. And at the same time, you’ve got this benefit from the Fed cutting interest rates tends to simulate the economy even more. Here in the U.S., the Fed’s trying to keep us out of recession. Well, with the Hong Kong dollar pegged to the U.S. dollar, they’re benefiting from the Fed’s rate cuts too, stimulating an already fast-growing economy. So I expect to see some pretty good returns from Hong Kong over the next year. There’s some great ETFs to play over there. That’s a good point about the rates. I never thought about that.

LC: So what are you recommending to some of your subscribers right now as far as ETFs go?

MB: In addition to agricultural ETFs, which I’m very bullish on, and as well Hong Kong based ETFs that kind of is a China play, I think one of the probably lowest-risk markets that has huge potential return is Japan right now. Japan’s market, of course, has been in the doghouse for years. It’s everybody’s favorite whipping boy, but it’s still the second largest stock exchange in the world.

There’s some huge multinational companies, like Sony is a great example that are really beaten-down stocks that are at good values. As a matter of fact, about 60 percent of all the companies listed in Tokyo trade at or below book value right now, which is almost unheard of for a major market like Japan or the U.S. or Europe. So it’s significantly undervalued. A great way to play that is with the iShares MSCI Japan ETF. The symbol on that is EWJ, and it trades right here on the New York Stock Exchange, so it’s an easy way to buy into the potential in Japan right now.