Most Investors Don’t Understand Exchange Traded Funds (ETFs)


Investors who have not purchased exchange-traded funds in their portfolios have avoided them, for the most part, because they “don’t know what they are,” according to Liz Skinner’s InvestmentNews article, “Investors Clueless about ETFs: Survey.” According to a survey of 2,000 adult investors conducted by Mintel Comperemedia, 64% of investors claimed ignorance about ETFs, and 15% of investors consider ETFs too complicated.

“Investors are still quite unfamiliar with ETFs,” Susan Menke, a vice president and behavioral economist at Mintel Comperemedia, was quoted as saying. “With all the new products coming out, advisers feel a little nervous about some of the more exotic ones out there,” she said, such as new ETFs that are actively managed.
Investors had purchased over $900 billion of ETFs as of Oct. 31, according to the Investment Company Institute. Ms. Mintel said she expects double-digit growth in the amount invested in ETFs every year for the next five years, at the expense of other products, especially mutual funds.

But there is good reason for being nervous about some of the more exotic ETFs. These exotic ETFs (such as leveraged and commodities ETFs) often contain complex derivatives of assets rather than the assets to which they are purportedly linked. As a result, these ETFs do not track those assets closely, as investors have been led to expect. The variance in performance between a leveraged ETF and the assets it is supposed to track can be quite large.

Leveraged ETFs are unusually volatile and high-risk. They are designed for day-trading and unsuitable for buy-and-hold investors.

All 52 leveraged ETFs in existence since Jan. 1, 2008, have lost money, according to Morningstar.

Approximately 140 ETFs have shut down since the beginning of 2008, according to the Wall Street Journal. These are typically ETFs that have not attracted enough capital to make it profitable for the managers.

When an ETF closes, shareholders can wind up paying new commissions and fees for a new investment to replace the closed fund, as well as capital-gains tax on any shares worth more than they initially paid. Investors should be very wary of these niche ETFs.

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