Exchange Traded Funds (ETF) Explosion Part II

by | Feb 22, 2007 | Asset Management

We’ve seen lots of articles and news pieces about the explosion of Exchange-Traded Funds, or ETF’s. Most of the opinions have been negative.  In fact, one writer compared this with the flood of closed-end funds created in the late 1920’s (before the stock market crashed).

My opinion: ETF’s are a great tool, and worth looking into.

Maybe you’ve heard 80% of most mutual fund managers have trouble beating the market two years in a row.  Combine that with the costs built in (sales charges, management fees) and you’re destined to fall behind whatever yardstick you are measuring with.

Some of the problems with mutual funds:
-New trading limits (especially international funds). Some managers got in trouble with “late trades” and now you (the small investor) have limits on how frequently you can trade these funds.
-No limit or stop orders on mutual funds
-You cannot short mutual funds
-Mutual funds do not trade options

Exchange Traded Funds:
-No trading limits, they’re bought/sold like stocks
-Limit and stop orders are OK
-The funds can be shorted
-Some ETF’s (not all) do trade options.

ETF’s are cheaper and flexible.  Still, WHY use them?

ETF’s usually blanket an entire SECTOR.  Like semiconductors.
Or bio-tech.

In the old days, if you wanted to get into a sector like autos,
you either had to build your own basket of auto stocks yourself,
or find a mutual fund that was heavily into that group.  Since
mutual funds are only required to show their holdings a few
times per year, you never really knew what the manager owned.
And how do you know if you (or the manager) “cherry-picked” the
right names?

Instead, with one ETF, you can buy the entire bio-tech sector
and then sell it (like a stock), when it reaches your price.
If you think a sector like “networking stocks” is due to fall,
you can sell an ETF of all networking stocks short and then buy
it back at a cheaper price.  Or buy puts on the ETF.

One more thing…remember, 80% of the price move in a stock comes
from what’s happening with the sector, and the overall market.
Don’t get hung up entirely on the fundamentals, like most people.

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