When it comes to investing in exchange traded funds, don’t judge a book by its cover.
ETF names can be misleading and may ultimately miss the target on describing what the tool is tracking. Investors who pay attention to the name of an ETF and little else can be left in the dark about what they’re really investing in. Don’t forget due diligence.
“A ‘Middle East & Africa’ fund with only 5% of assets in the Middle East? A ‘BRIC’ fund—you know, for Brazil, Russia, India and China—that has just 2% of its assets in Russia? A ‘homebuilders’ fund that has only 26% of its assets in companies that build homes,” Karen Damato for The WSJ wrote. [Does the ETF Index Provider Matter?]
The above illustrates exactly what is going on within the fund industry. Many times, the title of an ETF can be misleading and confusing for investors to really understand what they are investing in. ETFs are mimicking the index they track, so index composition is really what becomes important. Investors have to do ample research and homework before making an investment to avoid over exposure to a sector or stock. Furthermore, by knowing what stocks are held in the index, investors can be certain they have the right asset allocation within a portfolio. [How Diversified are Your ETFs?]
A few examples of this scenario is played out in the SPDR S&P Emerging Middle East & Africa (NYSEArca: GAF) with 91% of assets in South Africa, 4% in Morocco, and 5% in Egypt, the only country that qualifies as “emerging,” reports Damato. The area pf the market with potentially confusing names may lie among ETFs that pick holdings based on geography and country characteristics. The Guggenheim Frontier Markets (NYSEArca: FRN) holds assets in Chile, Columbia, Egypt and Peru, all of which are classified as “emerging.”
By taking the time to look at what stocks are included in the index an ETF is tracking investors can properly allocate their portfolios. If an ETF states “Middle East” or “Emerging” in the name, one cannot assume this is what they are going to get. [Traders Using ETFs in Place of Individual Stocks]
“A well-diversified portfolio holds investments from multiple asset classes. The benefit from this strategy is two-fold. First, portfolio risk is lowered, and second, performance is enhanced over time. Asset class selection plays an all important role in whether you earn benefits from diversification. Wall Street markets every asset class as the answer to an investor’s prayers, so it’s important to have a sound selection process,” Rick Ferri wrote for Forbes.
By simply looking under the hood at what stocks an ETF holds, investors can be assured they are that much closer to a properly diversified portfolio. After all, one should not judge a book by its cover, so why judge an ETF by a name?
Tisha Guerrero contributed to this article.