While mutual funds are the reigning heavyweights of the financial-services industry, exchange-traded funds that track small nooks and crannies of the investment world are growing in numbers even as they become more exotic. Some recent creations in this exploding industry sector include exchange-traded funds that invest in only those companies associated with smart phones (FONE), companies solely focused on providing water (PHO) or companies that have substantial assets or revenues in the country of Argentina (ARGT).
“ETF providers seem ready to adapt Apple’s marketing slogan, ‘We have an app for that,’ and say, ‘We have an ETF for that,’ ” said Cameron Short, a financial adviser with Stifel Nicolaus & Co. in Pittsburgh.
Exchange-traded funds, or ETFs, are investments that try to replicate the performance of a stock-market index such as the S&P 500 or a market sector such as energy and technology or commodities such as gold or silver.
ETFs are similar to mutual funds in that they offer investors partial ownership of an undivided pool of stocks and other assets. But the funds also offer exposure to many areas of investment that mutual funds do not.
Those currently on the market allow individuals to invest directly in 32 countries, 16 commodities, 14 currencies and 30 parts of the bond market.
Some of the funds invest in a broad basket of commodities while others place narrowly focused bets on industries such as solar energy or nanotechnology.
“There are no mutual funds that allow me to track the Japanese yen, Swiss franc or the Mexican peso,” said Matthew Tuttle, CEO of Tuttle Wealth Management in Stamford, Conn. But “there are ETFs that allow you to track those currencies.”
Unlike mutual funds, which can be redeemed only at the end of the day, ETFs can be bought and sold throughout the day, just like common stocks.
All that variety has its drawbacks, too.
According to BlackRock Inc., 173 new ETFs were launched in 2010 while 49 were delisted in 2009.
In addition to those that track exotic niche markets, there are dozens of inverse ETFs that move in the opposite direction of the index or asset that the fund is tracking. That means if the index or asset drops 10 percent, the value of the inverse ETF should rise 10 percent.
Leveraged ETFs use a combination of borrowed money and futures contracts to enhance the returns by two or three times the index or asset it tracks. With a “2x” leveraged ETF, if the value of the index falls 4 percent, your loss would be 8 percent and vice versa.
“Leveraged ETFs are meant to replicate an index’s performance on a daily basis [as opposed to an annual return],” said Eric Meerman, a financial adviser at Palisades Hudson Financial Group in Fort Lauderdale, Fla.
“Leveraged ETFs are meant for short-term trading. They have no place in a long-term, buy-and-hold investment portfolio,” Meerman said.
While leveraged ETFs charge higher fees because they are actively managed and strive for higher returns, most of the funds merely replicate an underlying index and usually charge lower fees than mutual funds that incur trading commissions and employ teams of analysts.
According to Morningstar, average mutual funds charge fees of 1.4 percent, whereas ETF expense ratios can be as low as 0.10 percent.
The one major advantage mutual funds have is that investors pay a commission each time they buy shares in an ETF, whereas mutual funds often do not charge a transaction fee.
“As soon as major custodians such as Fidelity and Charles Schwab make all ETF transactions charge-free, mutual funds will have a real tough time,” said Tuttle, adding that his firm uses ETFs in about 80 percent of its business.
Contact Tim Grant at [email protected] with questions.
