Thursday, October 28, 2010

Too many ETFs in the market: Going the way of mutual funds?

Are there too many ETFs, and more importantly, too many types of ETFs on the market? Too many, as in investors need a financial advisor to guide them? is all this proliferation of ETFs being caused by banks which rely on the this business to make money?
  • Exchange-traded funds may pass US$2-trillion in worldwide assets by 2011.
  • In Canada, ETFs are only 5% of the size of Canada's domestic mutual fund market In the U.S. they make up  10% penetration. 
This article fro the Ottawa Citizen sheds some light into this..

Some believe ETFs will soon be more popular than mutual funds. But, "as they more closely resemble the older industry, ETFs are repeating the older industry's bad habits".

"Just as the number of mutual funds passed stocks on exchanges, the same is happening with ETFs, said Stuart McKinnon, CEO of Pro-Financial. Most mutual fund investors don't get the returns their funds could provide because they switch at the wrong times, he said. This will happen with ETFs, as investors chase new niche products.

"Investors will get whipsawed and there will be disastrous results." Mutual funds argue their customers get a shot at beating indexes, though most active managed funds fail to beat them. They also claim ETFs never beat the index.

Joseph Witthohn of Philadelphia- based Jannery Montgomery Scott LLC expects ETFs to pass mutual funds but warns the real enemy is other ETFs. Manufacturers are slicing investments into narrower segments -- usually with higher fees. He prefers old-fashioned broadly diversified equity ETFs.

Witthohn worries investors don't understand what they're buying. (He cited one levered ETF meant to provide twice the return of the S&P500 index. The index returned 5.5% in 2007 but the ETF returned only 1.6% rather than the expected 11%.) Equities remain the heart of both industries but ETFs have spread to exotic "alternatives" like commodities, precious metals, real estate, private equity, hedge funds and emerging markets debt.

As complexity rises, the ETF cost advantage is narrowing, especially as actively managed ETFs proliferate.
Passive equity ETFs remain the heart of the industry but Cummings says flows into bond ETFs are doubling every 15 months in Canada. There are nine fixed-income sectors here with ETFs in most of them.

Cummings sees bond ETFs coexisting with traditional bond or GIC ladders, with ETFs providing greater diversification and ease of exit. FTSE America's income director of fixed-income research, Mike Bruno, says bond ETF sales are soaring but warned investors should cut exposure to longerduration bond ETFs, which could get hurt if interest rates rise late in 2011 or in 2012.

Aver y Shenfeld, chief economist of CIBC World Markets, said investors should lighten up on safe havens and focus on solid dividend-paying stocks. Here too, ETFs provide almost too much choice. The industry has moved from its roots in market-cap weighted index funds to ones that sort by fundamentals or use equalweighting strategies like BMO's.

The ironic result is average do-it-yourself investors who were once comfortable buying and holding a few broadly based ETFs may need full-time advisers after all. Exchanges keep creating exotic new indexes and manufacturers will build products to track them as long as investors buy. According to moderator Pat Bolland, the consensus is too many ETFs are being created and too many are overly complicated.

As with mutual funds, some will merge or be closed. Two ETFs focused on individual states (Texas and Oklahoma) have closed. In the end, as speakers emphasized, mutual funds or ETFs are just tools. It's how you use them that counts".

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