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The Future of ETFs


This past week, the Boca Raton Resort & Club hosted the Third Annual Inside ETFs Conference, the world’s largest exchange traded fund (ETF) event with over 750 participants. CNBC even broadcasted live from the event with interviews from ETF issuers, marketers, fund managers and others involved in the ETF business.

With over 800 ETFs in the U.S. and total ETF assets recently surpassing the $1 trillion mark [WSJ sub. req’d.], the ETF industry is certainly growing fast. But where are ETFs going? Let’s take a look.

Active vs. Passive

Actively-managed ETFs began to pop up in 2007 but have recently gained momentum due to their advantages over traditional mutual funds. Both actively-manged ETFs and mutual funds offer a low cost of entry and the convenience of having professional managers handle your money. However, ETFs typically have lower expense ratios, better tax advantages, greater trading flexibility and more transparency of underlying holdings than mutual funds.

One feature of ETFs is that their holdings are disclosed on a daily basis, creating greater transparency for individual investors.

Initially, this may seem counter-intuitive, as individuals could easily use the disclosed holdings to construct their own portfolios without paying a fee. To avoid this issue, ETF funds disclose their holdings daily after the markets close, to eliminate “front runners”.

Another concern is the lagging performance for actively managed funds overall. Historically, active managers haven’t been too successful when comparing their track record against passive funds.

Nevertheless, actively managed ETFs seem ready to explode. As of now, there are 15 funds but that could rise to more than 40 soon with the number of issuers willing to take a chance.

Specialization of ETFs within Asset Classes

Another theme to look for is the expansion of ETFs that are specialized within an asset class. There has been an increasing number of Commodity, Fixed Income, and Currency ETFs coming into the market with a focus on expanding within specific asset classes.

For example, United States Natural Gas Fund (UNG) is an ETF that tracks the front month of a natural gas futures contract. Two months ago, United States 12 Month Natural Gas Fund (UNL) was introduced to reflect the average prices of 12 consecutive months’ futures contracts equally weighted, instead of just the front month.

This trend can also be seen in Fixed Income, where investors now have the option of investing in all different types of ETFs including a 1-3 Month T-Bill ETF (BIL) or a 20+ Year Treasury Bond (TLT) depending on their investment strategies.

This specialization and expansion of ETFs within asset classes should provide sophisticated investors with plenty of tools to construct their portfolios.

Value & Region Based ETFs

You can now even invest in ETFs based on your faith. On December 21, 2009, the first Christian ETF (FOC) hit the market. This fund tracks a Christian index, which excludes companies involved in gambling, anti-personnel landmines, tobacco, alcohol, pornography, abortion, and/or stem cells.

For those who are strongly religious, these ETFs are a perfect solution to diversify across a broad range of stocks without worrying about investing in companies that are out of line with their faith’s beliefs.

Similarly, Geary Advisors LLC has recently launched two state-based ETFs: Oklahoma ETF (OOK) and a Texas ETF (TXF). These ETFs track indices that seek to measure the performance of publicly traded companies that are headquartered in Oklahoma and Texas, respectively.

These ETFs give individuals living in Texas and Oklahoma the opportunity to invest in their own state. Furthermore, Geary Advisors is now working on different types of state-based ETFs, including a mid-cap Texas ETF as well as a small-cap Texas ETF.

Summary

The ETF business has grown exponentially in recent years. Has it expanded too fast too soon? Despite its success, ETFs may have reached a saturation point with investors; there are many funds that aren’t able to gain traction due to lack of interest. These funds die slowly, shriveling up from lack of assets.

With the continuous inflow of new, exotic ETF funds, check the daily volume of the funds are before investing in them so you aren’t stuck with anything you can’t get out of.

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Comments

  1. I’ve been disappointed in ETF’s lately myself, not getting the same reaction from the market that I’m expecting from specific stocks et…

  2. So it’s an interesting article, but what exactly are ETFs? I think you glossed over or assumed a little too much knowledge from your readers…

  3. David Weliver says:

    Valid point, Jonathan.

    We linked to this quick description of ETFs towards the top of this post I but see now we could have done a better job pointing that out or defining them in the article.

  4. I’m curious to see the future with regards to some of the commodity ETFs like the Gold ETF (GLD). There is some controversy surrounding such ETFs namely whether or not they actually hold the amount of gold (or other commodity) that they claim to. It will be interesting to see how it plays out.

    Also, I think some of the leveraged ETFs will be under scrutiny especially if we have another leg down in the markets.

    Thanks!

  5. Jonathan,

    My apologies for omitting a description on ETFs.

    In a nut shell, they are funds that are composed of stocks, commodities, or whatever, that track a specific index. For example, there is an ETF (QQQQ) that tracks the Nasdaq, which means that you can pretty much gain exposure to all the Nasdaq stocks simply by buying that one ETF.

    They are similar to mutual funds, but they trade like a regular stock and have more transparency and better tax advantages than traditional mutual funds.

    ETFs are a great way to gain exposure to multiple asset classes as they are very accessible to individual investors.

    Let me know if I can clarify anything further.

    Thanks for your comment!

  6. Yes, the leveraged ETFs are actually one of the most popular ETFs because they are so risky. Traders love them because of their volatility.

    But yes, leveraged ETFs should NOT be even considered for everyday investors who have a buy-hold strategy because of their rough ups and downs.