Lipper Research Senior Analyst Don Cassidy on "Business for Breakfast" 1060 KRCN Tuesday - Exchange Traded Funds
Tuesday, November 15, 2005
Q. Don, we understand that the world of exchange-traded funds or "ETFs" hasreached a milestone.A. Right. There are now 200 of these ETFs listed in the USA, and theirassets are about $260 billion in total.
Q. Can we have a brief definition/description so our listeners know justwhat we're talking about?
A. Sure. An exchange-traded fund (ETF) is an index-based basket that tradesall day on a stock exchange. All but about 6 of them (bonds) are forstocks of various varieties, like sectors, industries, countries, styles,and major indices like the Dow Jones 30 or NASDAQ or the S&P 500.
Q. Have these been around for long?
A. The popular S&P 500 Spiders (SPY) were the first, starting in early1993. The next 17 (all country funds) were not created until 1996. thepopulation has about doubled in the past several years since the turn ofthe century.
Q. What is making ETFs as popular as they've become?
A. A combination of positive factors:
- low expense ratios since they are index funds.
- good tax efficiency due to their unique structuring.
- they trade all day long on an exchange, allowing various order types and transparent current pricing. Like stocks ETFs can be purchased through brokers.
- they don't involve back-end redemption fees or minimum holding periods like an increasing number of mutual funds are imposing.
- a basket makes investing in a concept fast and easy, without lots of study and one-stock selection risk.
- using discount brokers, you can get wide exposure for tiny commissions costs (one trade).
- if you are so inclined, you can short them, unlike mutual funds (in most cases, without waiting for an uptick).
Q. Who are some of the larger issuers of ETFs?
A. Certainly Barclays Global is the dominant one in terms of number offunds. The largest individual ETFs are the Spider, the Diamonds (Dow 30:DIA), and the NASDAQ 100 (QQQQ). Merrill Lynch has about 20 of the HOLDRsbrand ETFs out there.
Q. How big is the trading in ETFs now?
A. A few of the less prominent ones are not super active. But the betterknown ones, like SPY / DIA / QQQQ and the technology / energy / gold ETFsare very active, trading millions of shares a day. On an typical marketday, about seven or eight of the ten most active stocks on the AmEx areETFs!
Q. You mentioned that there are only a few BOND ETFs, Don.
A. Right. We predicted that they would not become widely used for bonds.There are so many other ways to deal in bonds including derivatives, sothere seems relatively little demand for added vehicles. They are veryhandy though, since you can deal in long US Treasuries (TLT), corporates(LQD), and short-end treasuries (SHY), on either the long or short side.Also, there is a very actively traded ETF for TIPS, (ticker TIP).
Q. Where can people get reliable information on these without a salespitch?
A. There are some good websites out there. I'd recommend:
Q. What kinds of strategies can investors implement using ETFs?
A. Everything from long-term investing to short-term trading, really! Hereare some examples:
- You can choose an industry or sector you like, and in some cases there are no regular mutual funds with such narrow focuses. You can take a loss on a fund for tax purposes but immediately buy a similar ETF and not run afoul of the wash-sale rule (except SPY and DIA funds).
- You can choose styles, like large-cap growth or small-cap value, and there is an ETF for each. You could even short the market without a down-tick if you think a decline is coming. You could hedge your portfolio without taking gains on existing long positions in stocks or funds.
- You could tweak your fund holdings up or down for industries you have strong opinions about. For example, you may have a health-care fund, but may be afraid of big pharmaceutical stocks or wish it held more in bio-tech.
- You can hedge your market exposure with broad or targeted shorts if you expect a decline.
- You could hedge big gainers through year-end and not take taxable gains until 2006.
Q. Are ETFs suitable for all investors?A. Except for the broad indexes, I'd say ETFs are better suited toexperienced rather than novice investor/traders. They tend to be volatilesince they are mainly narrow in focus, and unless you have your emotions incheck you may buy high and sell low. But for fine tuning and somelonger-term purposes, they are broadly useful for many people.
#
Don Cassidy is a Senior Research Analyst at Lipper specializing in fund flows, exchange-traded funds, (ETFs), closed-end funds, equity fund performance, and author of Trading on Volume (McGraw-HIll).
To read more Interviews, please visit the column archive.
