A mere blip on the radar screen compared to the ubiquitous presence of mutual funds and hedge funds, I hold the view it will be just a matter of time before Exchange Traded Funds (ETFs) gain the upper hand. Investors buy mutual funds for the simple reason they are sold, and rather than buying securities and funds based on your own decisions, most of you are sold them. You simply go to the salesman and ask him what is it you need and you blindly accept as the truth all that he says.
At the end of the day, however, I contend you will switch to ETFs because the intelligence of the average investor is too high not to see through the massive selling deception on the part of mutual fund distributors and peddlers of IPO stock.
Lest anyone think ETFs are just my preferred alternatives to mutual funds for the small investor, please read on. They are also useful to three groups of professional and sophisticated investors:
(1) One is the short-term after-markets trader, who could get a head start, for instance, on some market-sensitive news that breaks after NYSE/Nasdaq trading hours. As the ETFs are designed to be fungible, the arbitrage trader could pick up units in a Far East market cross-listed ETF such as the Nasdaq’s QQQ, and trade it later on the AMEX exchange.
(2) The second group will be those market professionals who already hold a basket of U.S. stocks, and who could use ETFs to hedge their stock positions.
(3) The third will be those investors — whether institutions or high net worth individuals — who buy the ETFs as strategic short to medium term holding, possibly as part of pension schemes or retirement savings, while they wait for lower entry points in specific stocks.
But all that still begs the question: are the ETFs any good for your portfolio, for strategic reasons? Well, count me among the increasing number of believers. Mutual funds for the “great unwashed” might be an $8 trillion industry in North America and hedge funds the darlings of the wealthy estate, but ETFs should play a leading role in every portfolio.
For coverage of the major equity markets, you can buy ETFs that cover the S&P 500 (large cap), the Dow 30 (large cap), the Nasdaq 100 (large-cap and mid-cap), S&P 400 (mid-cap), S&P 600 (small cap) and Russell 2000 (small cap). You can also buy the S&P Global 100 (large cap) as well as well-defined industry and sector funds and country and geographic region funds. So, as economic factors, commodity prices and interest rates change in the world, investors of ETFs can re-allocate portfolio positions accordingly.
This product is not just equity related. There are also fixed-income ETFs, which provide all the credit risk diversification and range of maturities you would like in a conservatively managed corporate bond fund, for instance. As interest rates are now entering a new long-term cycle of increasingly higher rates, many investors ought to be focused on this area of the capital market.
Let’s look at specific ways you might approach investing in the fixed-income ETF market, including euro bonds:
Trading on the London Stock Exchange is a Bond ETF called iShares iBoxx Euro Liquid Corporates ETF, which tracks a basket of investment-grade European corporate bonds.
In the U.S., there is the iShares GS $ InvesTop Corporate Bond Fund (AMEX: LQD), and the Aggregate Bond Fund (AMEX: AGG).
For U.S. government bonds, there is the Lehman 1-3 year Treasury Bond Fund (AMEX: SHY), the 7-10 year Treasury Bond Fund (AMEX: IEF) and the 20+ year Treasury Bond Fund (TLT). As rates are starting to move higher here, you will want to shorten the maturities of your bond holdings. You will want to allocate more of your holdings to equities; but only after the equity markets pull back in the near-term as investors work through sticker shock from higher interest rates, which affect borrowing and mortgage costs and dramatically impact costs of certain sectors like the financials (banks and utilities).
For many investors, particularly the small investor who doesn’t have a lot of time to monitor a portfolio, I recommend an All-ETF Portfolio. Depending on your age bracket and risk profile, this all-ETF portfolio might be even invested from 5% to 50% in Bond ETFs. You do not always have to be loaded up with equities. In fact, starting earlier this month, it is not a good time to be holding most equity sectors. Soon.
But, not for now.
By Bill Cara
Leave a Reply