Last week was an extremely busy one for new exchange-traded product issuance with 13 new funds coming to market for a total of 27 new launches in October. So far this year, 275 new funds have been launched while 15 have been delisted, resulting in a net gain of 260 exchange-traded products.

Continuing their partnership with Credit Suisse Asset Management, VelocityShares made a substantial addition to their line of exchange-traded notes (ETN) with the launch of eight new products last week. While their prior offerings were linked to volatility, their latest ETNs focus exclusively on leveraged exposure to precious metals.

VelocityShares 2x Long Platinum ETN (NYSE: LPLT) and VelocityShares 2x Inverse Platinum ETN (NYSE: IPLT) offer +/- 200 percent of the daily performance of the S&P GSCI Platinum Index and each charges an expense ratio of 1.35 percent.

VelocityShares 2x Long Palladium ETN (NYSE: LPAL) and VelocityShares 2x Inverse Palladium ETN (NYSE: IPAL) offer +/- 200 percent of the daily performance of the S&P GSCI Palladium Index and each charges an expense ratio of 1.35 percent.

VelocityShares 3x Long Gold ETN (NYSE: UGLD) and VelocityShares 3x Inverse Gold ETN (NYSE: DGLD) offer +/- 300 percent of the daily performance of the S&P GSCI Gold Index and each charges an expense ratio of 1.35 percent.

VelocityShares 3x Long Silver ETN (NYSE: USLV) and VelocityShares 3x Inverse Silver ETN (NYSE: UGLD) offer +/- 300 percent of the daily performance of the S&P GSCI Silver Index and each charges an expense ratio of 1.65 percent.

Given their ETN structure, none of the funds should exhibit any tracking error relative to their indexes over a single day. But since each fund’s leverage will reset daily, gains or losses can compound quickly, so their performance will deviate widely from their respective benchmarks’ performance over any holding periods longer than a single trading day.

If a benchmark gains 10 percent one day and loses 10 percent the next, investors would expect a 1 percent loss from their initial entry point:

Benchmark: (1 + 10 percent) x (1 – 10 percent) = 1.1 x 0.9 = 0.99, or a 1 percent loss.

Following this same logic, investors might expect a 3X long leveraged fund to lose 3 percent over the same two-day trading period. However, the ETNs’ daily resets change the math, as you can see in this equation:

3X Fund: (1 + 30 percent) x (1 – 30 percent) = 1.3 x 0.7 = 0.91, or a 9 percent loss.

Many investors failed to understand the impact of leverage on the returns of such exchange-traded products and have been understandably disappointed by the performance of similar products in the past.

Because of these leveraged effects, these funds should be avoided by most investors.

BlackRock’s iShares brand also had a busy week, launching five new exchange-traded funds (ETFs) of which four are devoted to low-volatility equities.

iShares MSCI Emerging Markets Minimum Volatility Index Fund (NYSE: EEMV) focuses on low-volatility names in countries such as Brazil, India and China. The fund’s annual expense ratio is 0.25 percent.

iShares MSCI All country World Minimum Volatility Index Fund (NYSE: ACWV) holds low-volatility stocks from around the world. The fund’s annual expense ratio is 0.35 percent.

iShares EAFE Minimum Volatility Index Fund (NYSE: EFAV) holds low-volatility names from developed markets outside of the US and Canada. That includes countries such as Australia, all of developed Europe, Israel, Hong Kong and Japan. The fund’s annual expense ratio is 0.20 percent.

Finally, iShares MSCI USA Minimum Volatility Index Fund (NYSE: USMV) focuses on low-volatility US names. The fund’s annual expense ratio is 0.15 percent.

The underlying indexes of these funds were developed by examining the historical volatility of stocks over periods ranging from several years to the most recent quarter. Those names exhibiting the lowest absolute volatility will be included in the indexes. The indexes will be rebalanced quarterly, but no more than 10 percent of each fund’s holdings will be turned over in any quarter.

The goal of the funds is to reduce volatility by about 25 percent as compared to the broader markets. At the same time, the indexes are carefully constructed so that they’re representative of the regions they’re tracking in terms of sector, market cap and style allocations.

Given the extremely low expense ratios charged by the funds, they will be very attractive investment vehicles once they establish solid trading volume. We expect them to outperform their non-volatility optimized counterparts.

The final new product from BlackRock is its iShares Emerging Markets Local Currency Bond Fund (NYSE: LEMB). This fund enters a crowded marketplace, as there are already a number of similar funds available to investors, including Market Vectors Emerging Markets Local Currency Bond ETF (NYSE: EMLC). And with an expense ratio of 0.60 percent, BlackRock’s offering isn’t even the least expensive fund available in this category.

Finally, Charles Schwab continues to bolster its presence in the exchange-traded product market with the launch of its Schwab US Dividend ETF (NYSE: SCHD).

The fund tracks the Dow Jones US Dividend 100 Index, a modified capitalization-weighted index comprised of the 100 highest yielding companies. The creators of the index screen dividend-paying stocks for quality, as well as yield. The index excludes weaker dividend payers by examining fundamental metrics such as cash flow to total debt, dividend growth rates and return on equity. Additionally, companies must have a track record of paying dividends to their shareholders for at least 10 years. Beyond that, other income-producing securities such as master limited partnerships, real estate investment trusts, preferred stock and convertibles are not eligible for inclusion in this index.

Like its parent index, the fund holds 100 companies with no single name accounting for more than 5 percent of assets, and no sector accounting for more than 25 percent of assets. As a result of the fund’s methodology, the consumer staples sector is currently its largest sector allocation at 23 percent of assets, followed by industrials at 17 percent of assets and consumer discretionary at 10 percent of assets. While it’s not surprising that financials receive only a 2 percent allocation–many firms in this sector were forced to reduce or suspend their dividends during the credit crisis–it’s noteworthy that the fund’s allocations to traditional dividend-oriented sectors such as utilities and telecommunications are in the low single digits.

Nevertheless, Schwab has constructed a compelling dividend fund. And true to its strategy of competing on price, Schwab US Dividend ETF charges an expense ratio of just 0.17 percent. While we were initially skeptical of Schwab’s foray into the ETF market, we’ve been impressed by the overall quality and low cost of its funds.

Portfolio Roundup

Both our portfolio and the S&P 500 were essentially flat from Tuesday, October 18 through yesterday’s close, but our Model Portfolio modestly beat its benchmark with a gain of 0.7 percent versus a 0.3 percent return for the S&P 500.

Despite the weak earnings reported thus far by the financial sector, SPDR S&P Regional Banking ETF (NYSE: KRE) was our top-performing holding for the week with a return of 3.5 percent. While analysts and investors have been critical of the quality of earnings produced by the major national banks, regional banks have fared better due to the higher quality of their loan portfolios. The smaller regionals have also enjoyed stronger loan growth than the majors, and that has proven to be a greater driver of earnings than some of the accounting gimmicks used by their larger peers. Continue buying SPDR S&P Regional Banking ETF under 31.

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