The WSJ (subscription required) had some interesting thoughts in “Exchange Traded Funds Gone Wild:”
Exchange-traded funds had such a humble start, it’s hard to believe what a crazy mélange they’ve become.
Back in 1993, the Standard & Poor’s Deposit Receipt (SPDR, pronounced Spider) launched, giving investors a fresh way to invest in the Standard & Poor’s 500-stock index. And, for a long time, ETFs matched this kind of simple, index-tracking investing.
But in the past few years, ETF providers (with the permission of the Securities and Exchange Commission) have sliced and diced investment ideas to such an extent that an investor can find an ETF for just about anything. According to the Investment Company Institute, a trade group, there were 956 ETFs at the end of February, with more than $1 trillion in assets in all.
While choice is generally a good thing, a good chunk of the nearly 1,000 ETFs should be avoided by most investors. They are too narrow, too risky and oftentimes simply faddish. Expect more of these mind-bending ETFs in the future.
The industry is gearing up to launch ETFs that focus on the automotive industry, bank loans and single-country sovereign bonds.
ETFs, like their mutual-fund cousins, like to chase the hot trends. The proliferation of certain types of concentrated funds are often signals that an idea is getting a bit too ripe. Think of the large number of Internet funds that blossomed just ahead of the Internet bubble bursting just over a decade ago.
Along with chasing the hot investment du jour, some ETFs are just intrinsically scary. The Direxion Daily China Bull 3X ETF (CZM) is such a fund, and there are many more like it. The “3X” (sometimes “2X”) indicates that a fund is using borrowed money to triple (3X) or double (2X) the investment bet on a specific index or investment objective. For example, the Direxion Daily China Bull 3X ETF uses borrowed money and complex “financial instruments” to try to triple the performance of the BNY ChinaSelect ADR index. China’s hot, and the fund is up 43.4% in the past year.
[Emphasis added]In yesterday’s post, I talked about the dangers of leveraged ETFs when, due to market conditions, investors attempt to stampede all at once through the very crowded exit doors.
I agree that an increasing choice of ETFs, along with lower fees, is a good thing for the investing public. However, a certain number of ETFs will not make it and fall by the wayside; always due to lack of volume, which translates into lack of interest.
That’s why my theme remains the same. Pick only those ETFs with a large average daily volume figures; personally I prefer over $10 million. That will keep you in the most liquid ETFs, which will have the added advantage of helping you get out when the heat is on, as discussed in FSB Is Worried About ETFs.
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