Wall Street

  • 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
I’ve discussed one of the most poorly performing ETFs – the United
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 [email protected])

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

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


Resource Prospector

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