ETFs in 2010: The Winners, the Losers and the Warnings The investment world's love affair with all things ETF did not wane in 2010, as their share of the market rose to $940 billion in assets, held in more than 1,000 exchange-traded funds.

There was plenty of excitement: Nearly 200 new distinct portfolio ETFs were introduced through Nov. 30, according to preliminary data from Morningstar (MORN). "ETF providers seemed ready to adapt Apple's (AAPL) marketing slogan, 'We have an app for that' and say 'We have an ETF for that,' " says Cameron Short, a certified investment management analyst with Stifel Nicolaus.

Then there was the flash crash drama. On May 6, about 20% of ETFs were temporarily snarled in the trading glitches that took place that day. At some point, about 210 of the then 980 ETFs changed hands at prices more than 50% below their ultimate closing price, according to Morningstar.

As for which funds have been hottest so far in 2010, preliminary data from Morningstar, Jan. 1 through Nov. 30, reveal winning categories: US ETF Commodities Precious Metals, up 118.38%; US ETF Equity Precious Metals, up 42.42%, US ETF Real Estate, up 23.75%; US ETF Small Growth, up 23.47% and US ETF Consumer Discretionary, up 23.46%. As for the laggards: US ETF Bear Market was down 29.55%; US ETF Commodities Energy, down 14.78%, US ETF Commodities Industrial Metals, down 5.42%; US ETF Europe Stock, down 3.81%, and US ETF Utilities down 1.12%.

There were a few lessons too. "Not all ETFs are the same," says John Bracket, a partner with BAR Financial. "Some of our MVP ETFs folded in 2010 because they did not have the asset base that would make them viable going forward. Some passive ETFs that we thought would be index trackers did not perform that way. We ran into illiquid ETFs that stunted our ability to get money out when we wanted it."

Tracking Commodities Is Trickier Than It Sounds

This year was all about commodities. "ETFs have become the vehicle of choice for exposure to the commodities market," says Short. But what concerns him is whether investors really get how a particular ETF, selected for exposure to a particular commodity, invests their money. ETFs gain exposure to a commodity by either investing directly in the futures market, or investing in publicly traded companies associated with a particular commodity. "Commodity ETFs rarely correlate exactly with the underlying commodity," Short explains.

"Investors need to determine if by purchasing ETFs they are acting as a trader (for the short term) or an investor (for the long-term)," he adds. Longer-term investors may not want to hold an ETF that invests directly in the futures market because the cost of rolling those futures contracts monthly and the possibility of contagion in future contract prices could hurt long term performance, he adds.
"ETFs that invest directly into the futures market are better suited for shorter-term investors who won't have to worry about the costs of rolling future contracts," says Short.

Beware of Leverage, Autopilot Investing, and Narrowness

Paul Brahim, executive vice president and managing director of BPU Investment Management, sites a couple of worrisome trends from 2010. "We are seeing growth in the number of ETFs being offered in three areas, and in each case, many investors are using ETFs in a way that can be dangerous to the health of their portfolio."

He points fingers at leveraged ETFs, which multiply the risks and rewards of the bets they make by investing on margin. Typically, a leveraged ETF will have as its goal shorting a universe of stocks, such as the S&P 500, and by leveraging, double their bet.

"These ETFs were designed for day-trading, but many small investors are buying them and holding them as a hedge, which is a mistake because when the bet goes wrong, the losses mount up quickly," says Brahim. Leveraged ETFs have caused some investors headaches by not delivering the expected result of double or triple performance versus their benchmark, adds Todd Millay, managing director of Choate Investment Advisors.

Second on Brahim's list are the suddenly popular target-date ETFs, which he says many people have started using in their self-directed 401(k)s, thinking that they are a "no-muss, no-fuss way of investing their money." Not so. "Target-date ETFs have all the disadvantages of target-date mutual funds, including the possibility of inappropriate allocation and the lack of control that the investor has over what's in the fund. Investors who use any target-date fund should remember that there should be no such thing as autopilot when it comes to an investment portfolio," he adds.

Next, he says narrow, narrow and more narrow is a trend is being misused by investors. "Financial companies continue to cut industry sectors into ever more narrow ETF slivers -- for example, ETFs that invest in water or corn, instead of ones that buy a basket of commodity companies. These ETFs are great for placing a bet on a narrow industry like solar energy or nanotechnology, but too many people buy a lot of 'slivered' ETFs and think they have achieved diversification, when in fact they have just placed a bunch of narrow bets," says Brahim.

Know Exactly What You're Investing In


While the proliferation of new launches ultimately should only benefit consumers, says W. Ross Singletary II, managing partner of Arcus Capital Partners, this trend does have the potential to create confusion. Eric Dunavant, president of Dunavant Wealth Group urges investors to be cautious about the type of ETFs they use. "Stick to traditional indexes like the S&P 500, Russell 2000, and MSCI EAFE," he advises. "If you want to diversify with other assets, stick to mutual funds with a longer track record of investing in those areas, especially commodities. These new ETFs may look fun and exciting, but if they are new, no one has any experience with what they will do. I wouldn't buy a mutual fund with less than 3 to 5 years of management experience, and I think the same goes for ETFs," he adds.

Then too, not only is the overcrowded market confusing, it at times can be dangerous because it can lead to low liquidity on certain ETFs, adds Dunavant. Low volume often leads to wide spreads between bid prices and ask prices. That can mean that two investors purchasing the same low-volume ETF at roughly the same time, could pay dramatically different prices, points out Don Moulton, director of financial services at Retirement & Tax Planning Specialists. Worse, he says, when trying to sell the ETF, investors might find few buyers, and those buyers might only offer prices far below what most would consider fair market value, especially if you're selling during a market panic.

"The explosion in the last year has opened up the world of ETFs that can be as dangerous to investors as a loaded gun, especially to someone who has no idea how to handle one," says Dunavant. "Yet the marketplace wants to sell them as an easy way to invest. This overcrowding can also be confusing to financial advisers, many who don't have the time to research the nuances of all the new ETFs."

The first rule of investing, reminds Moulton, "is know what you're investing in. Just because an investment product says it tracks the price of a given commodity, it's very important to understand how it tracks that commodity's price."

As for 2011, the crystal ball gazers predict that ETFs will continue to take market share from traditional mutual funds. "They are cheaper, more liquid, allow access to strategies not possible through mutual funds, and within the equity and fixed income space, ETFs often have superior investment returns as compared to similar mutual funds," says David Roda, CEO of Roda Asset Management. ETF specialization will go further, carving out even smaller nooks and crannies in the investment world. ETFs are still one of the fastest growing investment vehicles, and right now, experts don't expect anything will slow them down.


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Gary

Buy low And sell high. Buy soxl today. Down 10% Buy as price goes down . Sell when price goes up. Most people buy high and sell when price goes down. Fire your broker. Get online discount broker.

March 07 2011 at 3:14 PM Report abuse rate up rate down Reply
sonshirley

what do letters etfs stand for

December 07 2010 at 8:53 PM Report abuse +1 rate up rate down Reply
Dhubhgaill

Hey, All I see is comments on the current economy, most of which is derogatory to both sides. Nothing much about ETF's, only a few know what it is I guess. This article is about ETF's. By the way, writer made a big boo-boo. She never explained what an ETF is for the non-investors. All of us wish you spammers would get lost. How about ending spammers and also keeping to the topic, it's not a soapbox.

December 05 2010 at 12:43 PM Report abuse +1 rate up rate down Reply
BIG KELL

Mutual funds are ripoffs, particularly "load" funds. They offer you no protection against market sell offs. Try calling in to sell if the market tanks. With ETF's you can set "stops" to sell in such an event.

December 05 2010 at 10:24 AM Report abuse -1 rate up rate down Reply
jjnyka

JJay..my sound ADVISE? I'm looking for advice. For that manner? Try, for that matter.

December 04 2010 at 8:51 PM Report abuse rate up rate down Reply
1 reply to jjnyka's comment
Johnny Jay

jjnyka. If you are serious about looking advice you can e-mail me: vegasbaby4351@aol.com Make sure you give a proper message in the upper box so I don't ignore your e-mail & delete it. I do get a lot of junk mail that is deleted fast without reading.

December 05 2010 at 3:57 AM Report abuse rate up rate down Reply
kwayneu

I to got stuck on several of them also,I'm losing about $45000 on FAZ right now,some where along the line you should be able to trust your broker,that he knows whats he's doing,should have told me to get out after the first $2000 loss in a day, this is when these things were new,I don't think anyone knew what they would do except,wall street itself,they pushed these things pretty hard,when your broker is dumb and you're dumber and you buy them on margin and try to keep up with your call with cash its bad,everytime I see the word Direxion,they are the crooks invented FAZ,so I want to thank them for helping me lose my house and my broker that made sure I would not have any retirement on the other $100K, life is a bitch and sometimes you marry one. I'm already 65, so making up that money at work is impossible,no more stocks for me, Merry Christmas

December 04 2010 at 8:27 PM Report abuse rate up rate down Reply
Johnny Jay

Johnny Jay says: All the hype about ETF's is just amother tool for these mutual fund companies to suck the money from individual investors. They get your money & put you into a fund that is the so called ETF. Once they have your hard earned money your $$ gets moved around in the fund so you can't reap the true benefits. Many of the stocks in these ETF's pay a dividend, but you don't get to see most of these dividends. They tell you U are holding only 2 or 3 shrs. of the stock that pay the dividends so you see pennies on the dollar. The rest of that dividend money goes into a company slush fund so they can pay themselves large bonuses at the end of the year at your expense. The only way for you to benefit from all the dividends is to AVOID any purchase of ETF's or any other mutual fund for that manner. You are letting someone else control your money and they use it to their advantage not your's. MY SOUND ADVISE TO ANY INDIVIDUAL INVESTOR: Buy stocks on your own. Stay with the one's that pay a solid dividend and use the DRIP plans within the company. You can start as low as $25 on some companies but most want $100 as a starting point. The best way to buy these individual stocks is to open an account with one of those discount brokerages like TDAmeritrade, E=trade, Wealth Builders. They all charge a small fee to buy the stock & will reinvest ALL the dividends for you. This is a slow but steady process to gain wealth. I started 24 years ago with $300 on one stock. Now I have 29 that pay a total of $30,000+ annual dividends. Most of these are protected in a IRA or Roth IRA. If you need some help starting up you can buzz me via e-mail & I will help, There is NO cost for my guideance I just love to help people get weathly the correct way. Thanks J.J.

December 04 2010 at 5:33 PM Report abuse +2 rate up rate down Reply
cgravenkem

Shutting down the gulf of Mexico to drilling has cost the gov billions in revenue...2nd to IRS collections!! Is Obama trying to kill the economy on purpose?? Don't rasie my taxes while making moronic decisions!!

December 04 2010 at 1:27 PM Report abuse -3 rate up rate down Reply
Robert & Lisa

Obama promised to do better than George Bush. All he is doing is three times the same thing, and when asked about those failed policies his excuse is "Bush did it". When will you average democrats wake up? The Elite Thugs led by Obama have hijacked your party.

December 04 2010 at 11:48 AM Report abuse rate up rate down Reply
1 reply to Robert & Lisa's comment
fpfininc

sad but true, intelligence and being decent, is no better than being a fool and taking orders . we're doomed

December 05 2010 at 4:25 PM Report abuse rate up rate down Reply
Robert & Lisa

Just another example of George Soros's puppets, Obama and thugs, ruining things for the average American.

December 04 2010 at 9:17 AM Report abuse -2 rate up rate down Reply