|
Exchange
Traded Funds (ETFs)
Trade
like hedge fund managers
Sophisticated
investors such as hedge fund managers have recently adopted
exchange-traded funds (ETFs) as their favorite investment vehicle. But
there is no reason why individual investors can’t also exploit the
benefits of ETFs.
ETFs are
portfolios of stocks that replicate the performance of pretty much every
imaginable stock index. They offer you the opportunity to invest in a
particular market sector without researching individual stocks.
ETFs offer
advantages over index mutual funds. You can buy and sell ETFs just like
stocks, and you pay the same commissions as you would for trading
stocks. Most ETFs require no minimum investment, and there is no
required holding period. Unlike mutual funds that trade only once a day,
after the market closes, ETFs can be traded at any time during the day.
Another advantage is that ETFs can be sold short.
(Short
selling involves selling shares that you’ve borrowed from your broker,
and eventually buying the shares back at a lower price, and returning
them to your broker. You make money if the shares decline in price
during the period that you’re short, and lose money if they go up.)
Investing
Flexibility
ETFs give you almost unlimited flexibility in terms of market choices.
For instance,
if you think that large-cap growth stocks are about to take off, you
have a half-dozen or so large growth funds to choose from. You can find
a similar number of choices for small-cap value ETFs or any combination
of company size and valuation that you could want.
You can also
find funds specializing in specific industry sectors such as consumer
products, natural resources, regional banks, healthcare, real estate,
and many more.
ETFs also
give you the flexibility to invest in indexes representing foreign
countries or entire geographic regions. For instance, the iShares MSCI
EMU Index Fund seeks to emulate the returns of stocks in the European
Monetary Union. However, if you’d rather concentrate on a single
country, say Belgium, the iShares MSCI Belgium Index ETF reflects the
returns of the Morgan Stanley Belgium stock index.
Besides for
stock ETFs, there are also a handful of bond ETFs available. Investors
can use these, especially funds that purchase mostly long-term bonds, to
bet on the direction of interest rates. Remember that bond prices, and
hence, bond ETF share prices, move opposite to interest rates. That is,
bond prices drop when interest rates rise and vice versa. So you could
buy bond ETFs if you think that interest rates are likely to drop in the
coming months, and sell them short if you think interest rates are
heading up. However keep in mind that many smart investors have gone
broke trying to predict the direction of interest rates.
The most
popular ETFs in terms of the number of shares traded are the NASDAQ 100
Trust Shares, which represents the 100 largest NASDAQ stocks, and the
Standard and Poor's Depositary Receipts (SPDRs), which emulate the
S&P 500 index.
Looking at
returns, the iShares Goldman Sachs Networking fund, up 104 percent, and
the iShares MSCI Brazil Index fund, up 92 percent, were the best
performers over the past 12 months.
Researching
ETFs
There are at least four sites offering in-depth information on ETFs:
Yahoo Finance (finance.yahoo.com),
Morningstar (www.morningstar.com),
ETF Connect (www.etfconnect.com)
and ETF Zone (www.etfzone.com). As
their names imply, the latter two specialize in ETFs.
Of the four,
Morningstar is the only site that shows you the top 25 holdings of each
fund. Yahoo and ETF Connect show the top 10 holdings, while ETF Zone
shows only industry sector breakdowns and no individual stock holdings.
In my view,
seeing the top 25 holdings permits a better comparison of competing
funds. But curiously, unlike the other sites, Morningstar does not give
you any information about the goals of the index that the fund is
emulating. Instead, you have to guess at the investment objective from
the index title.
All four
sites offer ways of listing ETFs by index type, historical performance
and other measures, but I found Morningstar’s method the easiest to
use. There, you can list all ETFs and then sort them by category (e.g.
Europe stock, large value, etc.), by returns over various timeframes, or
by trading volume, which reflects the popularity of the fund among
investors.
So I suggest
starting with Morningstar, and then moving to one of the other sites to
verify that the fund’s investment goals are as you surmised from the
index name. To see the ETF list on Morningstar, select ETFs
on its homepage, then scroll down to the list of the most popular ETFs
based on trading volume, and then click on the Name heading to see the complete
ETF list. Once you have the list, click on a column heading such as
3-year return, to sort the list by that value.
ETFs give you
increased investing flexibility, but they are not always the best
solution. In many cases, managed mutual funds do a better job of
covering specific industries.
published 4/4/04 |
