ETF Overreach
by Richard
More proof that there can indeed be too much of a good thing.
The granddaddy of the ETF (Exchange Traded Fund) market is the original SPYder.
The idea was sound at the creation in 1993 and is still valid today. An index fund anchored to the S&P 500 with a rock bottom expense ratio of just 8 basis points, or 8/100 of a percent.
No surprise that this patriarch of the ETF universe now has over $76 billion in assets.
Unlike traditional mutual funds that can only be purchased at the close of each market day at the net asset value, the ETF trades throughout the market like any other stock, and like any other stock can be purchased on margin or sold short.
In other words, it does everything a traditional mutual fund is expected to do…and offers increased flexibility in the process.
Naturally, it’s success did not escape the gimlet eye of the other Wall Street firms.
So then the race was on…first to manufacture new indexes, and then to manufacture new ETFs to track these new indexes.
Which brings us to the current state of wretched excess.
And the inevitable fallout.
One of the fringe players in the field, XShares, recently announced the closure of 15 ultra narrowly defined health niche indexed funds. (Wall Street Journal, 8/25/08, page C6)
You can expect the rush for the exit to get frantic as this industry reverses its former metastatic growth.
I wouldn’t be surprised if the list of available, surviving ETFs were to be cut in half…twice…as the market continues to grope for the bottom and all the excess froth is wrung out.
The only way these funds can be profitable to their sponsors is to multiply their expense ratio across a large asset base.
Absent the growth in assets, there is nothing heroic in trying to stand your ground.
Best to fold your tent and move on.
This is one area where Wall Street is usually smarter than their customers….knowing when and how soon to cut their losses and regroup.
No one wants to draw the obvious comparison, but this episode is further evidence of the fact that Wall Street is a marketing machine, that will promote and sell any product, no matter how poorly conceived, if market demand can be sustained.
And the list just keeps on getting longer.
Auction Rate Securities. Collateralized Debt Obligations. Off balance sheet SIVs ( Special Investment Vehicles). Blind pool private equity funds. Equity indexed Annuities.
I could go on, but you get the point.
None of you ever woke up one morning with an uncontrollable craving for any of these products. They are sold rather than bought.
And as I’ve said many times, the street is better at selling than the average investor is at not buying.
How best to avoid getting nailed by the mean marketing machine?
Shorten your buying list. Stick with no-load funds from the big-shouldered discount brokers who dominate the fund supermarket category. Never pay a penny in commissions or transaction fees.
And if you want to construct a portfolio yourself, you never need to pay more than $7 getting in or out of a position.
If your ticket carries any additional costs, either on the front or back end, you are transferring your hard earned wealth to the trolls and gnomes lurking under the bridge.
