Wall Street’s ETF Tricks
- The Investors Triangle
- What are the hidden costs of ETFs?
- Exceptional ETFs
Today I’m going to blow the lid clean off of what I consider to be the biggest tar-pit for individual investors in the market today.
Exchanged Traded Funds – (ETFs) have been sold to the public as easy ways to buy into specific sectors in the stock market. They’re billed with attractive descriptors like “low-load mutual funds” or “poor man’s hedge funds” - or any of a variety of warm, fluffy names depicting them as “easy” ways to capture huge profits.
I’m reminded of an axiom known as the Designers Triangle, which states: a project can be done fast, cheap or good. Pick two.
I’ll amend this axiom for investors. The Investors Triangle states: an investment can be profitable, easy, or fast. Pick one. The obvious choice you’ll make is “profitable” – and these types of investments are rarely easy or fast.
Remind yourself of this axiom the next time someone tells you that a prospective investment has all three characteristics. Most of the best investors in the world made lots of money over a long period of time, and I don’t think any of them would tell you it was especially easy.
So when I see ETFs touted as “easy” ways to bank profits in specific sectors, I know I’m being sold something. What’s being sold is usually around .5% in fees. That’s cheap compared to most mutual funds. According to investopedia, the average stock mutual fund charges 1.3%-1.5% in total fees. ETFs are a steal if you compare their fees to what you’d pay a hedge fund manager: 2% of principle and 20% of profits.
But whereas a mutual or hedge fund manager has some kind of interest and ostensibly puts an effort into making sure the investments in his fund actually make money for his clients, an ETF manager has no such interest and puts forth no such effort.
So what are you paying an ETF manager for? Most of the time you’re just paying them .5% for their brilliant idea to bundle a group of securities together to sell to you.
And how fortuitous for them that you have such an interest! Time and time again, I’ve seen ETFs get launched at the peak of the popularity of their underlying security, only to watch the fund get slaughtered in the weeks and months afterwards as the sentiment and fundamentals for the underlying security begins to wane.
For unscrupulous fund managers, it couldn’t be easier than to do a little market research to find out the investment du jour, and launch a fund based on it. They don’t care if it goes up down or sideways, they only care that the idea is popular enough to sell the fund to a lot of investors for .5% of commission. The more popular, the better. And if you’ve been an investor for more than 5 minutes, you know that what’s popular is almost always not a great investment for very long.
In previous issues of the Resource Prospector I've discussed one of the most poorly performing ETFs – the United States Natural Gas Fund (NYSE: UNG). You can read this past issue (for free!) by clicking here. In short, and with the help of Eric Adamowsky, one of the top researchers here at Wyatt Investment Research, I’ve come to the conclusion that the managers who designed and launched this fund gave little heed to the idea that it might make money for people who bought it.
And unfortunately, I’ve found very few exceptions to this tendency for ETFs to underperform their own objectives – or to otherwise perform in a way that runs counter to what investors might think they should achieve.
(If you have any suggestions or questions about specific ETFs, please send me an email at editorial@resourceprospector.com)
So, it’s not enough for investors to be right on the trend. They also have to be right on the specific way to play the trend. And I wouldn’t be doing my job if I didn’t point out the booby traps on the road to profits.
As I said, there are exceptions to the rule. There are good ETFs to be found. My criticism of SPDR Gold Trust Shares (NYSE: GLD), the gold ETF has been constant and fair. I think gold investors can do a lot better than simply match gains made in gold’s price, but that’s the only thing this ETF is supposed to do. And it’s lived up to its goal:
In this chart, I divided the price of GLD by the price of one ounce of gold. Each GLD unit (or share) is supposed to track the price of 1/10 of an ounce of gold. You can see that since the fund launched in late 2004, it’s stayed within 5% of its goal most of the time.
As I’ve said, buying this ETF doesn’t give you the protection of owning actual physical gold, and it doesn’t provide the upside of profitable gold mining companies, so if you’re bullish on gold I think you can do much better.
As far as ETFs go, it’s not the worst. It lives up to its goals, and that’s all you can really ask.
I’ve been doing some research in collaboration with Ian Wyatt, our Chief Investment Strategist, as well as Jason Cimpl, our resident swing trader and Editor of Trademaster Daily Stock Alerts. Our goal is to find the three best commodity ETFs in the market today. We already have a couple picked out, and I anticipate completing the full report in the next couple weeks. Keep a close watch on your inbox, as I’ll be sending instructions on how to receive this report soon.
Good Investing,
Kevin McElroy
Editor
Resource Prospector
