Over the next year, ETF providers will be spending more time ensuring financial advisors understand what their ETF products are about and how to use them in client portfolios, writes Jessica Toonkel Marquez for InvestmentNews.

Martha Papariello, a principal with The Vanguard Group Inc., sees that educating advisors is essential as both retail ownership of ETFs increases and new niche ETF products are launched.

ETF providers want to get the point across that there are significant differences between core ETF products and niche offerings such as short and leveraged funds (how to use leveraged/inverse ETFs) or commodities-based ETFs (four types of commodity ETFs).

While the media and regulators have honed in on leveraged, inverse and commodity products, these two ETF products make up less than 10% of the entire ETF market. Jim Ross, senior managing director at State Street Global Advisors, points out that the word ETF encompasses a broad array of products.

Claymore Securities Inc. is using white papers and webinars to disseminate the general practices and structure of ETF investing. ETF Securities, iShares, WisdomTree, ProShares, Direxion and PowerShares also regularly host webinars and publish literature about various ETF products and issues facing the market.

As a result of greater advisor education, advisors will have the information they need to go on and educate their clients about ETFs. This education will also help them make the transition to ETFs away from mutual funds – doing this requires a lot of back office shifting and the education will give advisors the support they need to carry it out.

For more information on ETFs, visit our ETF 101 category.

Max Chen contributed to this article.

Vanguard

Vanguard Group Inc. is already the largest U.S. stock and bond mutual fund manager, and now the firm has set out to conquer the ETF industry, one sector at a time. Charles Stein for Bloomberg reports that Vanguard is the third-largest sponsor of ETFs, and has captured more than 30% of the money flowing into the business this year by charging an average fee of 0.15%; the industry average is 0.54%.

Vanguard now has $77 billion in ETFs, after inflows of $17.8 billion this year. The firm’s share of the market rose to 11%, up from 8.5% at the end of last year. (How to choose ETFs).

Their strategy of charging the lowest in fees is garnering the interest of many investors who are educated on the possibility that fees can cut into principal and earnings. (What else is important when selecting ETFs?).

But Vanguard has something else interesting at play: the firm’s founder, John Bogle, has been vocal in his criticism of ETFs. His chief complaint is that they encourage short-term trading. Bogle stepped down as Vanguard’s CEO in 1996.

For more stories about ETFs, visit our ETF 101 category. Among Vanguard’s lineup of funds include:

• Vanguard Emerging Markets ETF (NYSEArca: VWO): up 68.6% year-to-date
  

• Vanguard Europe Pacific ETF (NYSEArca: VEA): up 25.3% year-to-date

• Vanguard REIT Index ETF (NYSEArca: VNQ): up 15.4% year-to-date

The number of ETFs available in the market may be confusing, but there are so many choices that investors can customize their portfolios according to their personal preferences and strategy. The ultimate goal is usually the same (to make money), there are two primary categories investors fall into: those who use a fundamental strategy and those who prefer a sector strategy, explains Don Dion for TheStreet. We throw in a third strategy below, too.

Fundamental Strategy: Fundamental ETF portfolios are suitable for investors looking to take advantage of the cost efficiency and tax efficiency of ETFs over an extended time period. These portfolios are usually not traded very often and provide exposure to the broad market while meeting their needs for income.

Investors who find this strategy appealing often cite taxes as the primary lure.

• iShares Dow Jones Select Dividend Index (NYSEArca:DVY): up 4.8% year-to-date

• PowerShares QQQ (NYSEArca: QQQQ): up 42.9% year-to-date

Sector Strategy: A sector ETF strategy is designed to actively capture market trends. Some prefer  a momentum-based strategy to indicate the best times to enter and exit funds. ( The strategy you choose is just as important as the approach). These portfolios are considered active, as they are traded and monitored constantly.

• iShares iBoxx $ High Yield (NYSEArca: HYG): up 23.8% year-to-date

• PowerShares DB U.S. Dollar Bullish (NYSEArca: UDN): up 8.1% year-to-date

A Blend Strategy. We use trend following by monitoring the 200-day moving average in order to find those areas that are moving. By getting in and out of the market at set signals, you give yourself the opportunity to be in the markets for any potential long-term uptrend. The stop loss enables you to put a cap on your losses. The benefit of relying on market signals to determine where and when you invest also removes the “noise” that emotions can generate and cloud your judgment. Any ETF works with this strategy, whether it’s a broad-based, plain-vanilla fund or a more exotic, niche ETF. (How to get in on the rebound).

Always do some research on what you are implementing and consider the liquidity, underlying stocks and pricing taking place in the ETFs you choose.

For more stories about trend following, visit our trend following category.

While ETFs aim to track their underlying indexes as closely as they can, it’s noted on fact sheets that they “seek to replicate, to the extent possible.” The subtext is that while they try to avoid this scenario, a host of events could prevent this from happening. And while the word “error” can have negative connotations, keep in mind that error can work in your favor.

Larry MacDonald for Investopedia reports that the average tracking error for U.S.-listed ETFs was 0.52% in 2008; in some cases, ETFs exceeded their benchmarks and this is factored into the percentage. Sector, international and dividend ETFs tend to have higher absolute tracking errors; broad-based funds tend to have the lowest. What are some of the reasons it happens? MacDonald has a comprehensive list:

• Net Asset Value: When there are premiums and discounts to net asset value (NAV), this means that investors are bidding above or below the net asset value of the basket of stocks. While rare, premiums and discounts as high as 5% have been known to occur, particularly for thinly-traded ETFs.
• Optimization: When there are thinly-traded stocks in the benchmark index, the ETF provider can’t buy them influencing their prices a great deal, so they use a sample of only the most liquid stocks.
• Diversification Constraints: There are regulations set upon ETFs and mutual funds, and of note are two diversification requirements: no more than 25% of assets are permitted in any one security and securities with more than a 5% share are restricted to 50% of the fund.
• Cash Drag: ETFs have cash holdings, which can accumulate at intervals because of dividend payments, overnight balances and trading activity. The lag between receiving and reinvesting the cash can lead to differences between the index and the ETF. This is only a small contribution to tracking error.
• Index Changes: Indexes do get updated and when they do, some tracking error may occur if the ETF isn’t able to update.
• Capital Gains Distributions: On an after-tax basis, distributions can lead to differing performance between the ETF and the index.
• Securities Lending: Some providers can mitigate the impact of tracking error by lending securities to hedge funds or for short selling; the fees from this are then used to lower the error, if necessary.
• Currency Hedging: Factors affecting hedging costs are market volatility and interest-rate differentials, which impact the pricing and performance of forward contracts.
• Futures Roll: Rolling futures contracts (in which a provider sells an expiring contract and uses the money to buy the next contract) is repeated monthly. If contango is in place, there will be a loss. In backwardation, the tracking error will be positive. (What contango means).
• Constant Leverage: Leveraged and inverse ETFs use swaps, forwards and futures to replicate on a daily basis two or three times the direct or inverse return of a benchmark index. Since they rebalance daily, it can over time lead to tracking error. But on a daily basis, these ETFs perform as they should. (ETF Trends’ guide to leveraged and inverse ETFs).

More on tracking error can be found here. For more stories about ETFs, visit our ETF 101 category.

Holdings: EEG holds companies domiciled in emerging markets; some of the top companies in the fund include Russian natural gas company Gazprom, Brazilian energy company Petroleo Brasileiro, Latin American wireless provider America Movil and Bank of China.

Objective: EEG seeks to track the Dow Jones Emerging Markets Titans Composite Index, which is an index composed of a representative sample of 100 emerging market companies deemed by Dow Jones to be leaders in each of 10 sectors.

Things to Know

• Brazil is the top country, with 24.9% of the weighting. China has 24.3%, Russia has 13.4% and India has 13%. Other countries include Mexico, South Africa, Chile and Indonesia.
• Oil and gas is the top sector, weighted at 30.8%; financial is 22.1%; telecommunications is 11.6%; and basic materials is 9.3%.
• The expense ratio is 0.75%.
• EEG is a relative newcomer on the ETF scene – the fund launched on July 22.

The Latest News

• Emerging Global Advisors CEO Bob Holderith feels that interest in emerging markets should continue to expand. “It’s a 25-year growth story in its sixth year.” The positive growth outlook for emerging markets goes hand-in-hand with the changing demographic picture in these countries.
• Holderith notes that in most of these countries, there’s a huge young population, all looking for the “Western experience”: cell phones, iPods, dining out and more. (More on Emerging Global Advisors).
• Although the pace may eventually slow down, Barron’s reports that emerging markets still have room left to grow in the long haul. And for the time being, they may be the place to hide out as developed markets still work toward normalcy.
• Emerging markets already account for one-third of the global GDP and 10% of the world’s market capitalization.

Leveraged and inverse ETFs aim to have the funds’ movements correspond to the inverse of the relevant market indicator on a daily basis.  One must keep in mind that these ETFs come with risks, as well. The biggest issue to understand is the meaning of the word “daily” when it comes to these ETFs: daily, they will track their benchmarks. The further out an investor gets, the greater the risk that the fund won’t track its benchmark perfectly. This effect is heightened in volatile markets. (Check out our special report on these investment tools).

There are a growing number of providers of such ETFs today, including Direxion, ProShares and Rydex.

These funds can be appealing to investors with the risk appetite for several reasons:

• They can be used as a hedge if an investor believes the market is due for a short-term correction. If an investor is holding a position, but doesn’t necessarily want to sell it, then a leveraged or inverse ETF can be used to hedge against any potential loss.
• They can be used to capitalize on market movements. If an investor believes that the S&P 500 is due for a nice run, a leveraged ETF to maximize this movement might be just what the investor wants. (How leveraged ETFs are misunderstood).

These funds aren’t for everyone – always be fully aware of the risks and know how they work before you invest.

For more on leveraged and inverse ETFs, visit our leveraged ETFs category.

Some examples of common inverse and leveraged ETFs are:

• ProShares Short S&P 500 (SH), which seeks to give 100% of the inverse daily performance of the S&P 500.

• ProShares Ultra S&P 500 (SSO), which seeks to give 200% of the daily performance of the S&P 500.

• Emerging Markets Bear 3x Shares (EDZ), seeks to give 300% of the inverse daily performance of the MSCI Emerging Markets Index
  

• Technology Bull 3x Shares (TYH), seeks to give 300% of the daily performance of the Russell 1000 Technology Index

• Rydex 2x Russell 2000 (NYSEArca: RRY), seeks to give 200% of the daily performance of the Russell 2000 Index

• Rydex Inverse 2x S&P MidCap 400 (NYSEArca: RMS), seeks to give 200% of the inverse daily performance of the Mid Cap 400 Index

Kevin Grewal contributed to this article.

What’s driving gold prices today isn’t necessarily what drove them 40 or 100 years ago.

• Today, wealth preservation is the key driver for gold investment. Investors want to protect their assets, and gold holds its value, reports Eric Lam for the National Post.
• For most of the last decade, gold has performed well between September and December. Some investors may be considering these seasonal factors.
• The International Monetary Fund (IMF) sold 403 tonnes in September, and rumor has it that China is interested in it.
• India is also stepping up its gold holdings to 558 tonnes, up from 358 tonnes, as it seeks to diversify away from the U.S. dollar.
• In an attempt to revitalize the U.S. economy, the federal government has turned to printing massive amounts of money. The dollar has lost ground against its counterpart currencies, which has led many to believe that inflation is on the horizon.  As we all know, a good hedge against inflation is gold. (Other ways to hedge against inflation).
• Supply is becoming constrained. Of the world’s three biggest gold producers (China, Australia and South Africa), only China has increased production.

What’s the appeal of gold for the average investor? Lakshmi Iyer of Kotak Mahindra Mutual Funds states:

• Gold offers diversity, liquidity, safety and security to investors.
• Gold reduces the risk of losing money in the event that a preferred asset underperforms or when a specific sector is not doing well. (How to utilize precious metals).

For more stories on gold, visit our gold category.

Gaining access to gold is easy  through the use of the following ETFs:

• SPDR Gold Trust (NYSEArca: GLD): up 20.2% year-to-date

• iShares COMEX Gold Trust (NYSEArca: IAU): up 20% year-to-date

• PowerShares DB Gold Fund (NYSEArca: DGL): up 18.4% year-to-date

• ETFS Physical Swiss Gold Shares (NYSEArca: SGOL): up 7.1% since its inception

For full disclosure, Tom Lydon’s clients own shares of GLD.

Kevin Grewal contributed to this article.

Index IQ’s

Index IQ hosted a conference call that Roger Nusbaum on Seeking Alpha was able to get in on. (Read about their new ETFs here):

• IQ CPI Inflation Hedged ETF (NYSEArca: CPI)
  
• IQ ARB Global Resources ETF(NYSEArca: GRES)

Here are some facts he learned:

• For now the reported inflation environment is benign so CPI can be heavy in T-bills. At times of higher inflation, the fund will allocate more to things like gold, oil and even equities and real estate – possibly meaning REITs.
• The reason for no TIPS exposure in CPI is that it turns out that per their research, TIPS have a very low correlation to the reported inflation rate, which the CPI fund benchmarks against. The other reason cited is that longer-dated TIPs are also very sensitive to interest rates.
• GRES has large weightings in some stocks but larger weightings in others; this is so the fund will give an overall equal weight to eight different industries.
  

For more stories about ETFs, visit our new ETFs category.

As the Commodity Futures Trading Commission (CFTC) mulls over position limits for futures-based commodity ETFs, many providers are launching commodity equity funds to help sidestep the issue altogether. (The four types of commodity ETFs).

Cinthia Murphy for Index Universe lays out the facts:

• It’s not a one-to-one relationship. The long-term correlation between equities and futures is good, but not perfect.
• Investing in commodities-linked equities can be more volatile than tracking spot prices of commodities, warns Ed Lopez, product manager for Van Eck. “Any small movement in spot prices can actually affect producers greatly,” he says.
• Futures-based commodity index products may, over time, demonstrate significant tracking error against spot indexes because of the influence of contango, which is when the futures prices is above the expected future spot price.
• Equities are performing better than futures this year. Many investors may be a little skittish of futures while the CFTC officially decides what the limits will be. (How to avoid bubbles).

For more stories about commodities, visit our commodity category.

Some equities-based commodity ETFs:

• ALPS ETF Trusts Jefferies TR/J CRB Global Equity Index Fund (NYSEArca: CRBA)
• Market Vectors Agribusiness (NYSEArca: MOO)
• Market Vectors RVE Hard Assets Producers (NYSEArca: HAP)
  
• SPDR S&P Metals & Mining (NYSEArca: XME)

For every portfolio need, there is an ETF to fill it. Whether you’re looking in a niche area of the market or need an all-encompassing broad-based fund. Here is a simple breakdown from Aaron Levitt on Investopedia to help get you started.

Theme Funds: Some ETFs track an index centered around a theme or niche of the market, ranging from small-caps to solar energy, and everything in between. Examples of this include Claymore Global Solar Energy (NYSEArca:TAN) or Vanguard Small Cap ETF (NYSEArca:VB).

Broad-based “simple” ETFs: Broad-based funds are all-encompassing fund that give total exposure to a segment of the market. There are plenty of broad-based ETFs that can help get any portfolio on the right track. For instance, SPDR S&P 500 (NYSEArca: SPY) and Vanguard Total Stock Market (NYSEArca: VTI) can get you started. (Four rules for ETF investing).

Bonds: This area should not be forgotten, and can add the right amount of diversification from the equity market. Vanguard Total Bond Market (NYSEArca: BND) is a broad-based bond ETF that covers most bases. (How bonds are overcoming challenges).

Extras: Once the core of your portfolio is in place, you can play around with the extras and the niche or fancy funds. iShares S&P North American Natural Resources (NYSEArca: IGE) is a good example of this. (Do alternative ETFs belong in your portfolio?)

Becoming a good trader: Being a good trader involves education, time, patience, trial and error and a willingness to examine your good moves along with the bad ones. (10 tips to improve your ETF game).

A Plan: Last, but not least, you need a plan for investing. Assess your risk, your time horizon and your strategy. We use a trend following strategy, which you can read about in The ETF Trend Following Playbook.

For more stories about ETFs, visit our ETF 101 category.