What’s an ETF good for?
With over $1 trillion now in exchange-traded funds, it’s a good time to review just what they’re doing for investors, says this U.S. advisory.
Some people may still be wondering what all the fuss is about.
Turn to the business media these days and you invariably run across a story on exchange-traded funds.
They’re not new. The first ETF showed up in New York in 1993. But in the last few years they’ve been multiplying like rabbits.
Around the world, there is now more than $1 trillion invested in ETFs.
And they’ve been hotter than ever in 2010, one observer tells us.
Mr. Andrew Leckey writes for The Bull & Bear Financial Report. He discusses this growing investment phenomenon in his “Wall Street Report.” In the process, he interviews three leading experts in the field.
In turn, these experts volunteer a selection of ETFs that demonstrate just what a mixed bag of investments can be found in these funds.
Two popular reasons
There are two reasons ETFs have become so popular, says Mr. Lecky. First, they allow investors to hone in on specific targets. In its most basic form, of course, an ETF follows a specific stock market index.
But you can also invest in a specific industry, a specific commodity or bonds. Or you can invest in one segment of an industry. Or you can invest in a commodity by investing in a resource-rich country. And there are many more “ors” where those came from.
Second, they’re cheap. Unlike actively-managed mutual funds, these passively-managed investments carry small fees.
They are also traded on the exchange so that you can buy and sell during market hours, unlike mutual fund shares, which only trade at the end of the day.
Having reviewed the basics, Mr. Lecky turns to the experts.
In high demand
Mr. Mark Salzinger has a newsletter devoted entirely to these investments, The Investor’s ETF Report, which he publishes in a suburb of Nashville, Tennessee.
“I use ETFs mainly for targeted niche exposure because it is a good way to get at areas where a good mutual fund doesn’t exist,” he says. “In all my client accounts, I have both mutual funds and ETFs because I think a combination of the two is optimal.”
Thus he invests internationally through ETFs in areas where he can’t find a suitable mutual fund. Because Chilean copper is in high demand in China and India, he invests in iShares MSCI Chile ETF (NYSE-ECH). This ETF is currently trading at $54.58.
He also takes a somewhat riskier interest in the booming Brazilian market by means of Market Vectors Brazil Small Cap ETF (NYSE-BRF), which had a long run up in 2009 and is now at $45.40.
At home, he likes technology companies with little debt, lots of cash and “good product cycles.” His preferred investment is Vanguard Information Technology ETF (AMEX-VGT), which trades at $56.61.
Not a silver bullet
ETFs also have a tax advantage, says Mr. John Mauldin, president of an investment advisory firm in Dallas.
Outside a tax-deferred account, they are treated like stocks and thus involve no tax until they are sold, unlike mutual funds, which often generate taxable capital gains distributions. (This is equally true in Canada and the U.S., of course.)
Still, they should not be treated like a “silver bullet” to win big in the current market, he tells Mr. Leckey. Investors should buy them gradually rather than “tossing a large chunk of money in a specialized niche.”
One niche to start investing in, he believes, is biotechnology, which should have many new discoveries ahead of it in the coming decade. His two favourites are Health Care Select Sector SPDR (AMEX-SLD), which is trading at $32.30 and iShares Nasdaq Biotechnology Index Fund (NASDQ-IBB), which is at $91.59.
To cushion the blow of a possible bear market, he adds, investors should consider high dividend payers, like utiltities. He likes Utlities Select Sector SPDR (AMEX-XLU) and iShares S&P Global Utlities Index Fund (NYSE-JXI). They trade at $29.88 and $46.03, respectively.
The democratic way
Mr. Scott Burns, director of ETF Analysis at Morningstar Inc. in Chicago, thinks ETFs have given us a new democratic way of investing, “since they opened up areas of investment previously only for large pension funds and endowments.”
One of his favourite ETFs is in a very specific area of health care. iShares Dow Jones Medical Devices (NYSE-IHI) covers necessities like artificial hips and knee replacements, which people are not liable to skimp on, he says. It’s a high-margin business and the regulation risk factored into the industry’s stock prices during the health care debate “is far beyond anything that could actually occur.” This ETF trades at $58.61.
Mr. Burns has several cautions for investors. ETFs may not be expensive, but they’re not cost-free. You must pay transaction costs through a brokerage and this can add up.
And they are not risk-free either. 300 stocks may be safer than one stock, but there is always some risk involved, he stresses.
On the other hand, the average cost of an ETF is 55 basis points, compared to the average cost of 82 basis points for an index mutual fund and 125 basis points for a managed mutual fund.
However we assess the amount of risk involved in ETFs, there seems to be no risk whatsoever that they’re going away any time soon.
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