ETF Prime Archive

The Benefits Of ETFs

One of the most favorable characteristics that ETFs have is their flexibility, or ability to be traded like stocks (Forget Stocks). 

This characteristic is beneficial because it enables an investor to get continuous intraday pricing and the ability to buy or sell a basket of securities throughout the trading day.  This further translates to pricing transparency, in that at any given time, an investor knows exactly what the price of an ETF is.

Additionally, ETFs can be sold short, just like stocks.  This characteristic enables investors to bet against an entire sector, region, etc., as opposed to just one stock.  For example, if an investor wants to bet against financials, they can short the Financial Select SPDR (XLF) which will give them short positions in Bank Of America (BAC), JP Morgan Chase (JPM), Morgan Stanley (MS) and Wells Fargo (WFC) all in one trade; this will also reduce transaction costs.

Some other characteristics of ETFs include that they can be traded on margin and investors have the ability to buy/write call or put options on the ETFs.  ETFs also enable one to manage risk relatively easily through the use of limit and stop loss orders (Something To Consider With ETFs). 

When it comes to choices, there are plenty of ETFs to choose from.  There are basic indexes like the S&P 500 SPDR (SPY), sector specific indexes like the iShares Dow Jones US Real Estate (IYR), commodity based indexes like the US Oil Fund (USO), country specific indexes like the iShares MSCI Malaysia Index (EWM), currency specific indexes like the CurrencyShares Japanese Yen Trust (FXY) and many more.

In fact, ETFs continue to gain popularity as illustrated by the total net inflows of $14 billion in November, which marked the ninth straight month of net inflows into ETFs.

ETN Market Gets A Boost

Barclays Capital recently announced the launch of the first exchange traded note (ETN) that is traded in the Asian region (Other Ways To Play Asia).  This new ETN will be traded on the Singapore Exchange and will track the Dow Jones-UBS Commodity Index.  The ETN will enable investors to gain exposure to energy, industrial metals, precious metals, livestock and agriculture and will come with the benefit of not having tracking errors (More on Tracking Errors). 

The launch of this new product comes at a time when the iPath family of ETNs has been facing some hurdles.  U.S. listed commodity based ETNs linked to oil and natural gas, like the iPath S&P GSCI Crude Oil Ttl Rtn Idx ETN (OIL), came under pressure a few months ago when investors feared that the Commodities Future Trade Commission (CFTC) was going to impose strict position limits and restrictions that would eventually distort prices. 

A second blow to ETNs came last week when Barclays stopped issuing new shares of the iPath MSCI India ETN (INP) after Indian regulators barred it from trading offshore derivatives that were linked to Indian stocks (More on India).

Despite these temporary setbacks, the iPath ETNs continue to attract assets and offer investors an easy, cheap and relatively liquid way to access hard to reach markets.  As a result, there are more than 30 different iPath ETNs which comprise over $5 billion in market capitalization.

Be Aware Of ETF Tracking Errors

Exchange traded funds (ETFs) have become a very popular investment tool (Benefits Of ETFs) as investors have realized their numerous potential benefits over other types of investment vehicles.  However, it is equally important to understand that sometimes they suffer from what are referred to as tracking errors.

Tracking errors are the differences between the performance of an ETF and the underlying index that it tracks, and in general, the less tracking error, the better.  Here are four reasons tracking errors occur:

• Management Fees – In the ETF space, these are known as an ETF’s expense ratio and are taken directly out of net returns.  Naturally, the higher the expense ratio, the larger the tracking error.  Luckily, ETF expense ratios are generally lower than the expense ratios of mutual funds and are transparent to investors.
• Diversification Rules – The Securities and Exchange Commission (SEC) imposes strict diversification rules on ETFs, including one prohibiting an ETF from holding a single security comprising more than 25% of the ETF. For specialized or specific ETFs, at times, this can make it difficult for an ETF to track its index.
• Optimization Techniques – Some funds will buy only a subset of stocks that are in the underlying index in an attempt to provide performance similar to the index.  This technique is generally done to lower trading costs or to get around position limits.  The degree of optimization can affect the size of the tracking error.
• Dividend Drag – This occurs when there is cash in a fund.  Since no major index is constructed with a cash component, when a dividend is paid on shares inside an ETF, there is a lag between receiving and reinvesting the cash.  This error is generally very minimal, but it could potentially be a source of tracking error.

One way to get around tracking errors is through the use of ETNs (How To Use ETNs and ETFs), which are actually unsecured debt obligations of banks.  ETNs don’t have to worry about tracking errors because their returns are not based on the underlying securities, but instead, the ETN issuer guarantees the ETN holder a return that is an exact replica of the underlying index, less fees. 

Although ETNs get around the dilemma of tracking errors, they do come with an additional risk not found in ETFs; the credit risk of the debt issuer.  In and of itself, tracking errors are a disadvantage of ETFs; but at the end of the day, the advantages of these transparent investment tools far outweigh any disadvantage (Why To Use ETFs).

Massman Selected as Panelist for Inside ETFs Conference

Joe Massman, President & CEO of The ETF Store, has been selected as a panelist for the ETF 101 Workshop which kicks off the 3^rd Annual Inside ETFs Conference on January 10, 2010, in Boca Raton, Florida.  The Inside ETFs Conference is the industry’s largest event and the first and only ETF conference designed specifically for financial advisors.  The event is co-produced by Index Universe and Financial Advisor Magazine with sponsors such as iShares, Vanguard, StateStreet, Invesco Powershares, and Emerging Global Shares to name a few.  Over 500 are expected to attend with CNBC broadcasting live from the event.

As described on the conference website, “The Inside ETFs’ program is designed to bring financial advisors up to speed on all the latest developments in the ETF marketplace.  Over two-and-a-half days, our expertly chosen panels of investors, industry experts, academics and analysts will examine how ETFs can be used to create stronger risk-adjusted returns.”

Massman founded The ETF Store in 2008 to provide innovative investment solutions to individuals looking for alternatives to the commissions and high fees imbedded in the typical all-mutual fund portfolio.  Massman is also the founder of ETFBuzz.com, an online source for news and commentary about ETFs, and The ETF Institute, the first industry association for investment advisors utilizing ETFs in client portfolios.

China Gets a New ETF

As the popularity of emerging markets continues to grow (Emerging Market Choices), ETF provider Claymore Securities recently announced the launch of the newest member of its family, the Claymore China Technology ETF (CQQQ).

CQQQ is unique in that it gives investors the ability to gain direct exposure to technology, a sector expected to grow at an exponential rate in the coming years.   The new ETF seeks to track the AlphaShares China Technology Index, which measures the performance of publicly-traded companies based in mainland China, Hong Kong or Macau that are in the information technology sector.  The companies that are in the index must have an initial float-adjusted market capitalization of $200 million or greater and $150 million or greater for ongoing inclusion. 

Top fund holdings in this new ETF, which carries an expense ratio of 0.70%, include Tencent Holdings, Baidu.com and Nettease.com, and 78% of its assets are allocated to China while 28% are to Hong Kong (What to look for in an ETF).  What makes technology in this part of the world so attractive is that capital expenditures by the major players in the sector are expected to increase.

Of the emerging markets, Asia has drawn much attention due to its large growth and V-shaped recovery from the global recession.  More specifically, Hong Kong and China have been drawing the most attention (Why India is worth a look as well).  As for Hong Kong, the nation has seen GDP growth of more than 3% and has felt a domino effect from China’s growth and popularity.  Government stimulus plans, increases in domestic consumption, and favorable trade agreements are several reasons this region continues to grow quickly.

Some other ways to access China and Hong Kong are through the following:

• the Claymore China All-Cap ETF (YAO), which carries an expense ratio of 0.70% and primarily focuses on large cap companies
• the Claymore China Smal-Cap (HAO), which carries an expense ratio of 0.70% and focuses on small cap stocks
• the iShares MSCI Hong Kong Index (EWH), which carries an expense ratio of 0.52% and gives direct exposure to Hong Kong
• the Dow Jones Emerging Markets Composite Titan Index (EEG), which carries an expense ratio of 0.75%, allocates 24% of its index to China and enables one to reap the benefits of other emerging markets as well