Financial Planning Magazine On ETFs
A very good article in "Financial Planning Magazine" on ETFs. It's very lengthy so I've excerpted this down to the main concepts about ETFs. To read the whole article including a more thorough discussion on leveraged ETFs, bond ETFs and on actively managed ETFs I'd suggest going to the link and reading the whole story. Highlights are mine as usual. Comment @ the end.
ETFs' Glory Days
By Stacy Schultz, November 1, 2009
When State Street Global Advisors launched the first exchange-traded fund in January 1993, it was marketed primarily to institutions as a way for them to execute sophisticated trading strategies such as hedging. Finally, there was a low-cost, tax-efficient investment vehicle they could trade like a stock. ...... {W}hen the market took a turn for the worse in the summer of 2007......ETFs became the vehicle of choice. Suddenly, investors were taking real interest in the benefits of ETFs: low cost, tax efficiency, transparency and liquidity, to name a few. At a time when the market was swinging by hundreds of points a day, you could buy or sell a position and not wait for the market's close to find out the price. You could short ETFs; you could write options against them to hedge a position. Trading volumes soared ..........and ETF assets, which had been gaining heft steadily for years, hit an all-time high.
Today, 789 ETFs hold assets of $702.4 billion-a more than 90% rise over the past three years. Although this is meager compared with the $7 trillion mutual fund market, industry analysts now consider ETFs the most significant product development since mutual funds........
.....During the 18-month recession, ETFs accounted for 30% to 40% of trading volume and were the single biggest driver of flows. Thanks to educational efforts by fund providers and analysts that had been in full force long before the market began to sink, investors had begun to recognize the unique qualities ETFs offered. ....While liquidity drew many to these funds last year, their transparency also played a key role in attracting dollars. Because they are traded on a daily exchange, ETFs must report their performance and holdings each day on the fund's website. This transparency became prized after scandals ranging from Madoff to Stanford and beyond prompted investors to demand to know where-and how-their dollars were being deployed......
.....Some of the investors who flocked to ETFs were seeking much more than a safe haven. Over the past 10 years, ETFs have also been increasingly used as substitutes for single-stock exposure, and the recession only accelerated this trend. Investors grew wary of putting their money into any one name as even the most blue-chip of companies proved untrustworthy during the economic meltdown. "Advisors and professional investors were moving from buying the right individual equity to buying parts of the market or parts of the economic landscape, and ETFs are ideal for that," explains Michael Sapir, co-founder and CEO of ProFunds. "Most studies show that portfolios are more impacted by the sectors the securities are in than the individual securities."
Advisors themselves were slowly using ETFs as a way to diversify clients' portfolios while limiting risk. For years, advisors turned to sector mutual funds to gain this type of exposure, but as the market tanked and advisors looked for somewhere cheap and convenient to invest clients' money, ETFs took a front-row seat....... "People are migrating to baskets of securities to implement broad themes, whether it be oil, healthcare or financial services," says Dan Dolan, director of wealth management strategies at Select Sector SPDRs. "While people used to see sector investing as risky, it's now used as a way to mitigate risk."
Advisors also used ETFs to hedge client investments against the market's erratic fluctuations. Many invested in gold, for instance, namely SPDR Gold Shares, whose assets nearly doubled from just $18 billion last December to more than $34 billion this September......
....{A}dvisors {also} use these complex funds on a short-term basis to implement a variety of strategies ranging from mitigating risk to quickly enhancing return. And as the market shows strong signs of recovery, some advisors are even using leveraged ETFs to lure wary clients back into the market. "After a meltdown, people are hesitant to go back into the market," Sapir says. "Leveraged ETFs allow the appropriate client to inch back into the market with less principal at risk, getting a little bang for their buck on a daily basis."
But leveraged and inverse ETFs have undergone intense scrutiny this year as regulators question their suitability for most investment plans. On June 11, FINRA issued a statement declaring, "inverse and leveraged ETFs that are reset daily typically are unsuitable for retail investors who plan to hold them for longer than one trading day, particularly in volatile markets." The statement also warned financial institutions, saying "recommendations to customers must be suitable and based on a full understanding of the terms and features of the product."
The issue at hand was that the daily compounding that occurs in these funds makes them risky to hold for more than one day during volatile markets. ........While compounding can have its upside-earning the fund enhanced exposure to a rising index-the market's recent volatility has shone a harsh light on the negative effects of compounding in these products........
{Leveraged} ETF providers are the first to insist that their products aren't for everyone.....So just how long should leveraged ETFs be held? Most analysts and providers agree that, if rebalanced often-sometimes even daily-these funds can be safely held for extended periods of time. According to Sapir, who has done extensive research on the topic, the suggested holding period of a fund is dictated by its volatility.
"On diversified indexes like the S&P 500, there's a more than 90% chance that, over a month, a 2x S&P 500 ETF could get close to its daily target. You can get reasonably close to the daily target by rebalancing approximately every three months or every 80 to 90 days," he says. "The less volatility in the index over the short-term, the longer on average you can hold it and get closer to the index and the less frequently you need to rebalance." For riskier funds, such as a 2x China ETF, Sapir recommends more frequent rebalancing......
.......No matter how you look at it-or how you use them-it's easy to see that ETFs have come a long way in their short existence. But these products are still in their infancy, with plenty of room for growth and innovation......
.....The ETF industry has made significant strides over the last 16 years, but further consolidation is a given. The five-year product explosion came to a screeching halt last year, as 50 ETFs liquidated and four providers left the space. As of Oct. 7, 112 ETFs had less than $100 million in assets and 54 held less than $50 million, leading many to wonder if the industry can support nearly 800 funds. Now its future will depend on providers' ability to develop new products, recognize growth opportunities, and overcome obstacles. "There will be more assets and fewer products," Dolan says. "The ones that stick around will be bigger than ever. It's back to basics, survival of the fittest."
Link: http://www.financial-planning.com/fp_issues/2009_11/etfs-glory-days-2664389-1.html
ETFs' Glory Days
By Stacy Schultz, November 1, 2009
When State Street Global Advisors launched the first exchange-traded fund in January 1993, it was marketed primarily to institutions as a way for them to execute sophisticated trading strategies such as hedging. Finally, there was a low-cost, tax-efficient investment vehicle they could trade like a stock. ...... {W}hen the market took a turn for the worse in the summer of 2007......ETFs became the vehicle of choice. Suddenly, investors were taking real interest in the benefits of ETFs: low cost, tax efficiency, transparency and liquidity, to name a few. At a time when the market was swinging by hundreds of points a day, you could buy or sell a position and not wait for the market's close to find out the price. You could short ETFs; you could write options against them to hedge a position. Trading volumes soared ..........and ETF assets, which had been gaining heft steadily for years, hit an all-time high.
Today, 789 ETFs hold assets of $702.4 billion-a more than 90% rise over the past three years. Although this is meager compared with the $7 trillion mutual fund market, industry analysts now consider ETFs the most significant product development since mutual funds........
.....During the 18-month recession, ETFs accounted for 30% to 40% of trading volume and were the single biggest driver of flows. Thanks to educational efforts by fund providers and analysts that had been in full force long before the market began to sink, investors had begun to recognize the unique qualities ETFs offered. ....While liquidity drew many to these funds last year, their transparency also played a key role in attracting dollars. Because they are traded on a daily exchange, ETFs must report their performance and holdings each day on the fund's website. This transparency became prized after scandals ranging from Madoff to Stanford and beyond prompted investors to demand to know where-and how-their dollars were being deployed......
.....Some of the investors who flocked to ETFs were seeking much more than a safe haven. Over the past 10 years, ETFs have also been increasingly used as substitutes for single-stock exposure, and the recession only accelerated this trend. Investors grew wary of putting their money into any one name as even the most blue-chip of companies proved untrustworthy during the economic meltdown. "Advisors and professional investors were moving from buying the right individual equity to buying parts of the market or parts of the economic landscape, and ETFs are ideal for that," explains Michael Sapir, co-founder and CEO of ProFunds. "Most studies show that portfolios are more impacted by the sectors the securities are in than the individual securities."
Advisors themselves were slowly using ETFs as a way to diversify clients' portfolios while limiting risk. For years, advisors turned to sector mutual funds to gain this type of exposure, but as the market tanked and advisors looked for somewhere cheap and convenient to invest clients' money, ETFs took a front-row seat....... "People are migrating to baskets of securities to implement broad themes, whether it be oil, healthcare or financial services," says Dan Dolan, director of wealth management strategies at Select Sector SPDRs. "While people used to see sector investing as risky, it's now used as a way to mitigate risk."
Advisors also used ETFs to hedge client investments against the market's erratic fluctuations. Many invested in gold, for instance, namely SPDR Gold Shares, whose assets nearly doubled from just $18 billion last December to more than $34 billion this September......
....{A}dvisors {also} use these complex funds on a short-term basis to implement a variety of strategies ranging from mitigating risk to quickly enhancing return. And as the market shows strong signs of recovery, some advisors are even using leveraged ETFs to lure wary clients back into the market. "After a meltdown, people are hesitant to go back into the market," Sapir says. "Leveraged ETFs allow the appropriate client to inch back into the market with less principal at risk, getting a little bang for their buck on a daily basis."
But leveraged and inverse ETFs have undergone intense scrutiny this year as regulators question their suitability for most investment plans. On June 11, FINRA issued a statement declaring, "inverse and leveraged ETFs that are reset daily typically are unsuitable for retail investors who plan to hold them for longer than one trading day, particularly in volatile markets." The statement also warned financial institutions, saying "recommendations to customers must be suitable and based on a full understanding of the terms and features of the product."
The issue at hand was that the daily compounding that occurs in these funds makes them risky to hold for more than one day during volatile markets. ........While compounding can have its upside-earning the fund enhanced exposure to a rising index-the market's recent volatility has shone a harsh light on the negative effects of compounding in these products........
{Leveraged} ETF providers are the first to insist that their products aren't for everyone.....So just how long should leveraged ETFs be held? Most analysts and providers agree that, if rebalanced often-sometimes even daily-these funds can be safely held for extended periods of time. According to Sapir, who has done extensive research on the topic, the suggested holding period of a fund is dictated by its volatility.
"On diversified indexes like the S&P 500, there's a more than 90% chance that, over a month, a 2x S&P 500 ETF could get close to its daily target. You can get reasonably close to the daily target by rebalancing approximately every three months or every 80 to 90 days," he says. "The less volatility in the index over the short-term, the longer on average you can hold it and get closer to the index and the less frequently you need to rebalance." For riskier funds, such as a 2x China ETF, Sapir recommends more frequent rebalancing......
.......No matter how you look at it-or how you use them-it's easy to see that ETFs have come a long way in their short existence. But these products are still in their infancy, with plenty of room for growth and innovation......
.....The ETF industry has made significant strides over the last 16 years, but further consolidation is a given. The five-year product explosion came to a screeching halt last year, as 50 ETFs liquidated and four providers left the space. As of Oct. 7, 112 ETFs had less than $100 million in assets and 54 held less than $50 million, leading many to wonder if the industry can support nearly 800 funds. Now its future will depend on providers' ability to develop new products, recognize growth opportunities, and overcome obstacles. "There will be more assets and fewer products," Dolan says. "The ones that stick around will be bigger than ever. It's back to basics, survival of the fittest."
Link: http://www.financial-planning.com/fp_issues/2009_11/etfs-glory-days-2664389-1.html
Comment: There is a controversy on leveraged ETFs that reset daily which I believe largely misses the forest before the trees. I will discuss this at some point but I will note today that I have used these leveraged ETFs in the past and currently do so in what I consider appropriate size and in appropriate accounts to try and limit risk. I will discuss this in more detail in a future post. We have been using ETFs since the mid 2000s and almost exclusively since 2005. It is nice to see that some of what we have been preaching and discussing with clients these past four years is now being validated in articles such as this one.
*Long ETFs related to the S&P 500 and GLD in client and personal accounts.
posted by CR English at 6:52 AM
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