Many new ETFs have wide appeal and include a broad range of investment opportunities. They can also come with extra costs that investors should be aware of.
Most investors would agree when we say that Exchange-Traded Funds (ETFs) started out as the most benign investment innovation that has come along in our lifetimes.
However, as often happens after the successful launch of any new investment product, the financial industry soon came up with new ETFs. The new models came with a wider variety of investor appeal, along with new wrinkles and extra costs.
The first ETFs had a simple goal: cutting fees for investors. Each new ETF aimed to copy the performance of a particular stock index (minus the costs of creating and running the ETF, of course). Most of the model indices were well-known, widely followed collections of actively traded stocks.
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New ETFs can be volatile, even with the diversification they offer.
Know how broadly diversified the fund is, so you can determine its volatility. The broader the ETF, the less volatility it should have.
Know the economic stability of countries when investing in international ETFs.
Know the liquidity of new ETFs you invest in.
Determine how distributions and gains from the new ETFs you buy will be taxed.
Consider buying new ETFs in a lump sum to avoid multiple brokerage fees.
These days, new ETFs aim to broaden investment opportunities for investors, and at the same time create new profit opportunities for the financial companies that sponsor them.
Instead of giving you a low-cost way to copy the results of a standard market index, many new ETFs aim to mimic much narrower indices and higher-risk strategies. They may give you a way to invest in a particular foreign stock market—coupled, in many cases, with an arrangement that hedges against movements in the foreign currency in which that foreign market carries on its trading. Or they may give you a way to participate in a particular stock-market strategy.
New ETFs typically carry higher MERs than the old ones. Based solely on MERs, they’re still cheaper to invest in than conventional mutual funds. But MERs are just the start. Many new ETFs need to delve into frequent trading or derivatives of various sorts to accomplish their stated objectives. Although they don’t raise the ETF’s MER, these added costs act as a drain on its capital. But the effect is the same. They act as a drag on the capital growth in an ETF, or speed the shrinkage in its value.
You might say these ETFs act as loss leaders for the industry. The institutions involved make little profit if any on the initial sale and yearly MER. They make up for it with profits from associated activities.
We don’t mean to suggest that all new ETFs are aimed at fleecing investors. But we do believe investment quality varies just as widely with new ETFs as it does with new stock issues. In both cases, only a handful are worth holding, and only if you find their investment premise irresistible. Otherwise, you can find better investments.
What is an ETF?
ETF is an acronym for exchange traded fund. Exchange traded funds are used to track indexes as closely as possible, since it’s impractical for investors to actually buy all the stocks in an index outright.
Exchange-traded funds trade on stock exchanges, just like stocks. Investors can buy them on margin, or sell them short. The best exchange-traded funds offer well-diversified, tax-efficient portfolios with exceptionally low management fees.
Does your portfolio include newer ETFs or legacy ETFs? Have you noticed a difference in fees, or have the been comparable? Please share your experience in the comments.
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