The ETF industry has attracted $5 trillion in investment money globally, but many still do not fully understand the investment vehicle and the various strategies that they track.
“I think the top challenge for the ETF industry, ironically, is still education. When I started covering ETFs in ’97, I thought I would have a job for two years, and everyone would know what they were, and we’d move on,” Deborah Fuhr, co-founder and managing partner for research firm ETFGI, told MarketWatch.
The ongoing need for education is largely associated with the growing range of asset classes and strategies. Fuhr pointed to the evolving indices that ETFs track, such as the sudden growth of smart beta or rules-based indexing methodologies.
“People need to make sure that they understand the benchmarks,” Fuhr said. “Do you want something that is market cap-weighted, equal-weighted — some other structure of benchmark? Recently we’ve seen how the mainland Chinese market is opening up. So what does it mean to invest in China A-shares?”
ETF Due Diligence
When it comes down to it, investors should take the time to do their due diligence and fully understand an ETF’s underlying holdings.
“But the reality is even those products do what they say they’re going to do, if you read the prospectus. But people often don’t read the prospectus,” Fuhr said. “That’s where we’ve seen some problems, where people have thought, ‘Oh, I’ll buy this and expect X.’ If you don’t do your homework, you probably are going to be surprised and disappointed.”
The misunderstandings are only increasing as more ETF providers pile up on a single investment theme or strategy. Two more more ETFs may track the same sector, style or category, but no two ETFs are built the same. Investors have to carefully consider sector exposures, style weights and indexing methodologies, along with costs considerations, among others, to fully understand what they are buying into.
For more information on ETFs, visit our ETF 101 category.