Exchange Traded Funky

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.

Source: Drugpolicy.org

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

By |2017-07-28T07:08:54-04:00July 28th, 2017|Global Market Update|Comments Off on Exchange Traded Funky

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