But are they how to ride the indices?
Exchange Traded Funds (ETFs) have created a major question for fund managers looking for returns- Are they the way to handle these messy indices? They’re usually targeted to match indices and a good portfolio of ETFs can cover a wide range of possibilities. The drivers in this type of investment are different to normal portfolio management, which can include an array of various values and issues. There’s no debt collection situation in ETFs as there is in normal portfolio investments, where losses have to be balanced relative to capital, etc. They’re very straightforward investments, where performance is easy to measure.
The index factor
The best example of an ETF investment is probably the blue chip type of ETF. These ETFs are like barometers, containing major market leaders and also good traders in their own right on the markets. A blue chip ETF will also be less reactive to the market, except for major moves, where, naturally, their mix values take effect.
The typical blue chip ETF is geared to exploit the market weighting of these major stocks, as well as their performance. Index based trading benefits from major stocks moving, which drives up the index or prevents it from falling as a result of other stock price changes.
With ETFs, the ability to be instantly converted into cash on the market is another major selling point. Mutuals and listed trusts can do this, but they’re comparatively primitive investments, usually not as focused on indices, and unable to develop their index moves rapidly into instantly meaningful performance with a dollar value attached.
Downsides?
The natural question for investors in the current climate is, “How good are ETFs as defensive investments?” The answer has to be qualified, because like all investments, ETFs have both individual and generic characters, and so do their indices.
A truly dramatic example of the difference in the ETF market and the stock market was during the mortgage securities bust. The mortgage index based ETFs also went into a nose dive, but did a complete reversal in a few days, (not years or never) when investors realized these ETFs were holding top quality mortgage portfolios which weren’t affected by the big blowout.
The downside is often based on individual ETFs. Some ETFs are very highly performance-based, and have been accused of unrealistic claims to performance, like making profits at X times the index moves. Short selling ETFs have been targeted for a range of issues including performance and the losses suffered by investors as the market went back up. (It’s a matter of opinion whether some people really understand that the hedging issues in short selling aren’t some sort of debt recovery system or not.)
These are the exceptions, however, and a systematic comparison of ETFs and their indexes makes very interesting reading for fund managers. There’s over a trillion dollars invested in these funds, and that money’s there for a reason. If you’re looking for a good, flexible investment, ETFs have the answers that other types of investment just don’t have. Shop around, develop an informed opinion, and do some modeling of your options. It doesn’t get dull.
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