Good Investments or Gimmicks?

Understanding what an ETF owns, how it’s managed and how an ETF fits within an investor’s overall portfolio is more critical than ever.







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    Good Investments or Gimmicks?

    Good Investments or Gimmicks?

    The ETF industry may still have further market share growth ahead of it, but it has surely matured by the measure of the depth and breadth of the investment selection it provides investors. Aside from offering vehicles for replicating well-known indices, such as the S&P 500, and lesser-known indices, like that of FTSE All World ex U.S., ETFs now afford access to all manner of industry sectors and investment themes. Consider some of the more unusual ones:

    • Solactive Obesity Index
    • Spirited Funds/ETFMG Whiskey & Spirits Index
    • iBillionaire Index
    • Nifty 50 Index

    And, of course, the sign that ETFs have truly arrived … the ETF of the ETF industry—The ETF Industry Exposure & Financial Services ETF (TETF)!

    Divining the Good from the Gimmick

    There is a tendency in any industry to take a great product and carry it to the extreme. Consider the number of cola variations on a supermarket shelf, collateralized debt obligations or NFL programming.

    Here are some questions investors may want to ask before they invest in thematic ETFs:

    What is the time horizon for holding the ETF? Many of the themes ETFs are pursuing may not be sustainable over an extended time period. It may represent the smart thinking for the moment, but ideas can lose steam with time. Be prepared to consider many ETFs as more tactical investments than a core strategic portfolio holding.

    Is the timing right? History may prove that an investor may be correct about a certain theme (e.g., infrastructure), but if there has already been a substantial run-up in prices, it may be a bad time to commit funds to such stocks.

    What is the exposure to the theme? Some themes may not have enough companies with undiluted or heavy exposure to the theme (think drones or robotics). Thus, some ETFs may hold investments in large diversified companies involved in the theme, but whose revenues are not materially impacted by the theme (think drones and owning Boeing).

    How does the ETF change the portfolio’s risk level? Some themes or indices are so narrow that an ETF may hold a disproportionate share of its assets in a small number of stocks, which can introduce added volatility to the portfolio. Moreover, adding a thematic ETF may heighten the exposure to certain sectors or stocks already held in core portfolio holdings.

    With nearly 2,000 ETFs trading in the United States, investment in ETFs has become increasingly complex and specialized. Understanding what an ETF owns, how it’s managed and how an ETF fits within an investor’s overall portfolio is more critical than ever.

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