Exchange traded funds (ETFs) are cheap and nifty investment tools used for tracking major indexes. But there are some voices of censure apropos of this relatively new asset class.
ETFs cover a wide range of areas in the global economy and are gaining more and more attention, so much so that there are bound to be some gripes about them, writes Kirk Shinkle for U.S. News. Here are some of the more frequent criticisms in the ETF industry and responses to them:
- Tracking errors. ETFs may not perfectly reflect their underlying indexes. For 2008, the average tracking error in U.S.-listed ETFs was 0.52%. Last year’s market volatility and specialized funds also attributed to a higher percentage of error. Usually, low liquidity in underlying securities have higher tracking errors. Bear in mind that big tracking error is relatively rare, and most of the time, they’re very close to their underlying indexes.
- Index makeup. ETF providers may have similar-sounding funds for a specific area or sector, but they can be composed of completely different companies. Potential investors should take the time to look into the specific holdings of ETFs and understand how the underlying index is constructed.
- Oil. Popular oil ETFs may not have risen as much as the actual price of the commodity it tracks, leading to confusion on the part of investors. But some oil ETFs track crude futures, which roughly means the returns of the index will follow future prices and not the spot price.
- International funds. ETFs exchange accessibility in some hard-to-access foreign markets for exactness. International funds will have higher percentage in tracking errors because the underlying indexes are harder to track, and sometimes even more so in subsectors.
- Leveraged funds. Recently, FINRA asked members to have more restraint in recommending leveraged funds to customers. The organization wanted to emphasize that leveraged funds were meant for day-traders since volatility can diminish returns if held for longer periods. This should help educate investors who remain confused about these funds and how they work.
- Just because we can does it mean we should? John Bogle analyzed ETF investors’ trading habits and found that frequent trading usually reduced overall returns. Investors should have a strategy, such as following the 200-day moving average, to ensure that they’re in and out of the markets based on specific signals.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.