As the exchange traded fund business advances beyond $1 trillion in assets under management, the newer products being rolled out are becoming increasingly complex. Investors can choose from leveraged ETFs and other sophisticated strategies, but for many investors, a simple approach could be the best one.
“ETFs have democratized investing by making several previously inaccessible asset classes available to the masses,” writes Morningstar ETF analyst Timothy Strauts.
ETFs have given individuals a lower-cost, liquid vehicle for investing in currency and commodity markets, various bond indexes, short and leveraged indexes and just about every niche and broad sector available. Yet the use of derivatives in certain funds has also caused confusion for many investors because when used improperly, they can cause damage in a portfolio, Strauts says. [Are ETFs to Blame for Dwindling Stock trading Volume?]
Basically, ETFs have brought sophisticated investing strategies and asset classes to the individual investor. This can be a good thing, as institutional investors are also putting capital into these investments, creating necessary liquidity. However, the danger lies in investing in the unknown, or uber complicated. Many investors just don’t understand the mechanics of various sectors and this is what leads to investors getting burned. [Lower Risk Stock ETFs to Consider]
The solution? It is imperative for investors to educate themselves and research an ETF before buying in. Many times, when one looks at the actual stock breakdown of the basket, it can deviate wildly from what the title of the fund reads. If a particular strategy seems unclear, it is best to avoid it until a professional can be consulted. Many times, the more complex funds do require daily monitoring, unlike the classic broad based fund. [ETFs Seen Hitting $2 Trillion By 2015: Research]
“ETFs must stick to publicly traded securities and sometimes there is no good way to invest in certain investment themes in the public markets. In this case, the nomenclature of the fund is vastly different from the fundamentals that will drive the eventual outcome,” Strauts explains. [ETFs Sending Mutual Funds The Way of the 8 Track?]
Google Trends research shows that ETFs have slowly but surely taken “mind share” from mutual funds, writes Tadas Viskanta at the Abnormal Returns blog.
“There is every indication that ETFs will continue to take share from traditional open-end mutual funds. The traditional money managers are chomping at the bit to enter the actively managed ETF space,” he said. “These firms recognize the fact that ETFs are the next growth vehicles for the asset management industry.”
Yet Viskanta notes that mutual fund assets of $12 trillion still dwarf the ETF industry’s $1 trillion. Also, ETFs have yet to make meaningful headway in cracking the 401(k) market, which is still dominated by mutual funds.
“ETFs are a big part of what active investors and traders use these days. It is simply worth putting into perspective the fact that ETFs are not yet, and will not be for some time, the primary investing vehicle for most Americans,” he wrote. “Investing, whether it is in an open-end fund or ETF, is still investing. Just the structure is changed.”
Tisha Guerrero contributed to this article.