Sellers of exchange traded funds are pandering to the latest investment fad and putting investors at peril, according to David K. Randall in his March 1 Forbes article, “Rearview ETFs.”
They are taking advantage of an unfortunate quirk of human nature, which leads investors to chase last year’s hot sector in an effort to replicate eye-popping returns. This phenomenon is so well-known that it even has a name: “recency,” the tendency to assume the near future will look a lot like the recent past. Unfortunately, recency often leads investors to climb into hot sectors just as they’re cooling, according to the article.
Emerging markets returned 80% last year, leading almost every investor to wish he’d had greater exposure. It’s easy to get such exposure these days by purchasing one of the ten emerging markets exchange traded funds, or the eight that invest in single emerging countries, that were launched last year.
Emerging market stocks are down 5% so far this year.
If this scenario sounds familiar, consider that in 2000 the market was flooded with 71 mutual funds specializing in tech stocks, just in time to carry investors over a cliff. The tech-heavy Nasdaq is down 50% in the past decade.
Instead recommending last year’s hot sector, investment advisers should act in their clients’ best interest by recommending a diverse, low-cost portfolio of assets. Exchange traded funds that are limited to broad-based market indexes, such as the SPDR S&P 500, can play a role in creating such a portfolio. SPDR S&P 500 is still the industry Goliath with $73 billion in assets. Its annual fees are 9 basis points (0.09% of assets).
Last year, however, Wall Street created 139 new exchange traded funds, only a dozen of which were broad market trackers, according to Morningstar. Eight of those index funds were offered by Charles Schwab. Vanguard Group also offers index exchange traded funds.
The other newly created exchange traded funds were concentrated in, among other things, real estate, Brazilian stocks, commodities ranging from platinum to natural gas (capitalizing on the recent jump in commodities prices), and ? surprise ? emerging markets offerings, like the GlobalShares FTSE Emerging Markets Fund and Market Vectors Poland ETF.
“When the ducks quack, Wall Street feeds them,” quipped Randall. Wall Street is not satisfying a legitimate need, however. It’s all about transferring investors’ money to the House (Wall Street), which always wins in the end. High startup costs mean that an ETF must quickly attract $50 million to be viable. Pulling that off in a crowded market of 1,000 ETFs means offering either what the public wants (gold, Brazil) or what it can be persuaded to want (a short bet on Treasuries).
As the industry strays ever further from index funds, the risks for investors multiply. Illiquidity is one such risk. The Global X FTSE Nordic 30 has attracted only $4 million, and trading volume is so thin that it was quoted recently with a 1.85% spread between the bid and ask prices, according to the article. By contrast, the SPDR S&P 500 trades at a spread of a penny, or 0.01%.
Investors who have lost money in exchange traded funds may have compelling claims to recover their losses and should have their accounts evaluated by an attorney who specializes in securities arbitration.
Page Perry is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 30 occasions. Page Perry’s attorneys are actively involved in representing institutional and corporate investors in exchange traded fund cases. For further information, please contact us.