The market for exchange-traded funds continues its explosive growth. Some are worried it may have gone too far: ETF assets jumped fivefold to $422 billion in the period 2002-2006, in comparison with the more than $10 trillion in conventional mutual funds. Exchange-traded funds are index-based products that allow you to buy shares in a portfolio of securities. ETFs are flying off the shelves of financial-services firms as 150 new products were offered last year, bringing the total number of funds to 357. 300 new ones are in registration to kick off in 2007.
“Are we giving individual investors another bullet with which to shoot themselves in the foot?'’ says Tom Lydon, founder of ETFtrends.com, a Web site and blog that focuses on ETFs. “With a certain number of investors, you don’t have to give them a bullet…The majority of ETF investors are somewhat responsible,'’ Lydon says. “About one-third are institutional investors, one- third financial advisers and one-third individuals.'’
An example of a recent highly specialised ETF is the HealthShares Diagnostic ETF, which focuses on companies that make medical diagnostic devices. Run by XShares Advisors LLC in New York, the ETF had only 22 stocks in its holdings as of Feb. 22, according to data compiled by Bloomberg. It costs 0.75 percent a year to manage the HealthShares fund. Compare this with the ultra low costs of a core ETF such as Vanguard Health Care ETF. One is costly and narrow, the other highly cost-eefective and diversified.
Other excellent names in the space include the Vanguard Total Stock Market ETF, which allows you to own most of the US market spectrum & the iShares Lehman Aggregate Bond Fund for US Treasuries.
iShares MSCI EAFE Index EFA tracks a widely used benchmark for foreign developed-market stocks, with exposure to companies in Europe, Australia, and Asia. The $37.1 billion portfolio counts the likes of BP, HSBC and Toyota among its more than 800 holdings. Performance has been good as markets have rewarded global investing in recent years with an average annualized return of 14.38% over the five years ended Dec. 29, slightly ahead of its style peers, according to Standard & Poor’s, with a .35% expense ratio.
Over in the UK the ETF is starting to expand as well. iShares recently launched the iShares FTSE UK All Stocks Gilt and the iShares £ Index-linked gilts, bringing its total of ETFs up to 46, 17 of which were launched in 2006, with funds covering emerging markets, Asia, Turkey and even the infrastructure market.
We recommend prudent use of ETFs in our various model portfolios for flexible, cost-effective tactical and strategic allocation, as a complement to high quality collective funds and to selected undervalued individual equities.
