Is there an ETF for everything?
Photo: Jack Moreh Source: Free Range Stock Photo
It sure seems like it. ETFs used to be primarily an efficient way to invest in a broad market index, like the S&P 500 or an aggregate bond index. Then they branched off into market sectors: small cap stocks, tech companies, country funds like the UK or China. All this seemed like a reasonable way to diversify a portfolio. And it’s so convenient: instead of trying to pick winning stocks, investors can select a broad area of the market. All you need is a brokerage account.
ETFs are also the investment of choice for robo-advisors. Their porfolios – driven by the answers you give to them in your customer profile – are almost always a set of ETFs designed to provide a model asset allocation. As robo-advisors have grown, ETF assets have grown with them.
But now ETFs are branching out into more esoteric strategies. Here’s a partial list of some new ones: low volatility factor, momentum factor, size factor, multi-factor, leveraged, inverse, contrarian, hedge fund replication, clean energy, infrastructure, and so on. There are active ETFs that use dynamic strategies. There are ETFs that focus on social goals, like whether a company has women in leadership positions, or that take positions in new industries, like driverless cars or medical marijuana.
All this innovation doesn’t come cheap. ETFs can carry high internal fees, just like mutual funds. Sometimes they pay extra to a broker or other third party. Every ETF is based on an index. Somebody has to construct that index, and the ETF pays a fee to the index provider. If the index company is related to the fund manager, that’s a way to disguise revenues. And even low-fee ETFs can sell their trading data, or use it themselves in high-speed trading arbitrage. Whenever there’s a financial innovation, it seems like the industry figures out a way to extract more fees. Investors should ask pointed questions and be careful.
When the iPhone came out the catch-phrase was, “There’s an app for that.” Increasingly now we seem to say, “There’s an ETF for that.”
Douglas R. Tengdin, CFA