A number of investors may have been caught by surprise when it comes to certain exchange traded funds (ETFs). If you’re among them, there are some simple steps you can take when it comes to avoiding unpleasant surprises so you don’t get burned again.
Many ETFs are straightforward in both their performance and in how they’re taxed. However, there are also an increasing number of ETFs that go beyond the plain vanilla treatment.
Take short and leveraged funds. Using them in a manner for which they weren’t intended is going to lead to some disappointment on the part of the investor.
Complaints concerning leveraged or inverse ETFs are often based upon the long-term returns that the investor expected and did not receive. The issue is that these funds are not made to be buy-and-hold investments, something the providers are very open about. They are to be traded daily. But it is up to the investor to understand the intricacies of how these funds work, reports Matthew Hougan for Index Universe.
Commodity ETFs are another area of confusion for some investors.
Those who are chapped about the commodity-focused funds must inform themselves about the risks of both contango and backwardation, as well as realize that crude oil futures are a different animal from spot crude. Spot prices and future prices also differ, so be aware.
If the current price of oil is lower than the future price, it’s a classic case of contango. In the opposite situation, it’s known as backwardation. Most commodity funds buy the “near month” contract, then roll it over before it expires and the next month’s contract is bought (known as “rolling forward.”)
The risk is that a negative roll yield could cause the net asset value (NAV) of a fund to drift from the spot price.
Different funds hold different things: some commodity funds hold futures, others hold the physical commodity and others hold companies involved in the production of a specific commodity. Our commodity special report lists some of the largest ones and details what’s in them.
These ETFs work exactly as they ought to. For investors looking at them, it’s worth a minute or two to drill down into a fund and identify potential risks, what the fund holds and any other information you can discover about it. As ETFs get more exotic, it’s going to become increasingly important for investors to do the necessary research to avoid getting hurt.
ETF providers are working hard on the education front, with comprehensive education sections on their blogs, as well as hosting podcasts and webinars for investors to learn more. In addition to that, we have an ETF education page you can peruse for articles on different types of funds.
For more stories about leveraged and commodity funds, view our category pages.