The Herald Bulletin
---- — 2013 has been a tough year for many money managers. Nearly any attempt to seek diversification within a portfolio has punished as many international markets and different sectors and fixed income have been unable to keep up with the all-mighty U.S. large cap.
This has posed a problem from mutual fund managers who are tasked with the responsibility of sticking to their style box – meaning they must adhere to keeping their investments in specific asset groups. With investors becoming frustrated with varying levels of fees within mutual funds and the often inflexibility of their management, many investors are turning to Exchange traded funds as their vehicle of choice for investing.
Exchange traded funds (ETF) have provided investors with more options for their portfolio at a time when mutual funds ruled the world. These investment vehicles trade throughout the day like stocks but have a basket of holdings similar to a mutual fund. An ETF can be viewed as a specialist while a mutual fund is more like a general practitioner.
A general practitioner treats patients with everyday medical needs, one minute he might be performing a routine checkup while the next he is diagnosing the flu, they serve an important role and can user their expertise across many fields of medicine. However, a specialist is oftentimes an expert in a single field of medicine, whether it is the heart, brain or bones. Each ETF has a specialty; an exchange traded fund that tracks a technology index should not be expected to one day start investing in grocery stores or oil companies.
Investors need options, many don’t want to be pigeonholed into just being able to allocate their assets to a handful of general go anywhere, invest in anything funds. This is one of the reasons for the increase in popularity of ETFs.
However, not all exchange traded funds are created equal, investors still need to be weary of the cost of owning various funds, as many ETFs track the same indices while having varying expenses.
The ugly cousin of the exchange traded fund is the exchange traded note (ETN). Although they have similar names, they are created in nearly a completely different fashion. An ETN is an investment based on a promise; unlike ETFs they do not buy or hold the underlying assets to replicate the index for which they track. According to a recent FINRA press release on the risks of ETNs, they can be redeemed by the issuer at any time, which could be at a price less than what the investor purchased it for.
Another risk that needs to be considered, which FINRA points out, is the possibility the issuer of the exchange traded note defaults, which could have an obviously significant impact on the note’s price. Like all investments, there are some inherent risks that must be considered and weighed.
Asking these questions and examining the perils that we are exposed to comes with the territory of allocating capital. Some are more critical than others, but being aware of them is important.
Joseph “Big Joe” Clark, whose column is published Saturdays, is a certified financial planner. He can be reached at firstname.lastname@example.org or 640-1524.