Members of our Inner Circle service increasingly ask us about investing in exchange traded funds (ETFs). These funds have gained popularity among investors in recent years, mainly because many ETFs offer very low management fees.

Exchange traded funds are set up to mirror the performance of a stock-market index or sub-index. They hold a more-or-less fixed selection of securities that represent the holdings that go into the calculation of the index or sub-index.

Exchange traded funds trade on stock exchanges, just like stocks. Investors can buy them on margin or sell them short. We recommend a number of carefully selected exchange-traded funds in our Canadian Wealth Advisor newsletter.

Avoid losses: Be wary of theme-based exchange traded funds

It’s important to note that not all ETFs are created equal. For example, there are a lot of ETFs that have been created to tap into popular, but risky, themes and fads. So you need to be very selective with your ETF holdings.

An Inner Circle member recently asked us about an ETF that’s tied to a risky theme (“alternative energy” in this case). To give you a sense of the risks involved in this type of investment, we’d like to share our member’s question, along with our response. We hope you enjoy and profit from it.

Q: Hello Pat. I am currently holding the following in my RRSP account: Market Vectors Nuclear Energy ETF. What do you think about this exchange-traded fund? Thank you for your advice.

A: Market Vectors Nuclear Energy ETF, $22.80, symbol NLR on New York (Shares outstanding: 7.4 million; Market cap: $167.2 million), aims to track the performance of the DAXglobal Nuclear Energy Index. The index includes 24 companies in the nuclear-energy industry. These firms are located in a number of countries.

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To be included in the index, a company must be publicly traded, have a market cap over $150 million U.S. and meet certain minimum trading requirements. The index is divided into seven different areas of the nuclear industry: uranium mining (36.6%), nuclear generation (26.0%), plant infrastructure (22.5%), uranium storage (4.5%), nuclear conglomerates (4.4%), uranium enrichment (3.5%) and nuclear fuel transport (2.5%).

The index’s top 10 holdings are Mitsubishi Heavy Industries (8.5%), Constellation Energy Group (8.2%), Electricite de France (7.7%), Exelon Corp. (7.5%), Cameco (7.4%), Uranium One (5.2%), JGC Corp. (4.6%), Paladin Energy (4.3%), Areva SA (4.1%) and Uranium Participation Corp. (4.1%).

Market Vectors Nuclear Energy ETF first sold units to the public for $50 each, and began trading on New York in August 2007. The fund holds 24 stocks. It has an expense ratio of 0.61%.

Nuclear power’s long-term outlook is positive. That’s because global electricity demand is growing in the face of heightened concern about power generated using conventional fuels. Oil, for example, is a non-renewable resource. Coal is also non-renewable, and releases large amounts of pollutants when it is burned.

Technological advances in both uranium mining and nuclear-reactor construction have improved nuclear power’s safety record, addressed a number of environmental concerns and increased efficiency. As a result, there is growing acceptance that nuclear energy is a necessary part of a “green” energy solution.

Nuclear industry faces unique risks

Despite these advantages, the nuclear industry faces a number of short-term problems, including lower uranium prices, delays in building costly new nuclear plants, the weak global economy and ongoing problems in credit markets. All of these problems will likely hold back Market Vectors Nuclear Energy ETF.

We don’t recommend Market Vectors Nuclear Energy ETF.

If you have investment questions, or if you’d like to ask us about stocks or other types of investments you’re considering buying (or selling), you should join my Inner Circle service. Click here to learn more.