Money Matters: The overabundance of Exchange Traded Funds

By Christopher Raby The Daily Record Newswire From the launch of the Standard & Poor's Depository Receipts, SPY, in the early 1990s, Exchange Traded Funds have been increasing in popularity. With asset levels expected to reach $2 trillion at the end of 2011 (Blackrock), ETFs still occupy only a fraction of the market cap of traditional mutual funds, which hold assets over $23 trillion (ICI). However, underwriters have been quick to bring new ETFs public, slicing and dicing the global market in new ways. Increasing the scope and depth of ETFs will allow the investor to pick an investment that is most suited to their needs. But, while increased exposure to specific areas of the market may have its benefits; narrow industry segments and low liquidity are just two of the pitfalls of the overabundance of ETFs. A benefit to the wide range of ETFs can be seen in the variety of small-cap ETFs available. Consider two of the major small cap ETFs that are available from iShares (IWM) and Vanguard (VB). At first glance, these ETFs seem to invest in essentially the same securities. However, looking through the funds, one realizes they are dramatically different. The top four holdings are similar, but from that point, sector investments and weights in particular companies differ greatly. Year-to-date returns in IWM are 16.74 percent, compared to 17.87 percent in the Vanguard fund. The differences in the composition of the respective indices, even for the same asset class, can result in significantly different returns. An example of the increasing variety of ETFs is the handful of currency-tracking ETFs by Rydex Investments. In December 2005, Rydex launched the Euro Currency Trust (FXE) that tracks the spot price of the Euro, plus a discounted overnight Euro deposit rate. This investment was received with great fanfare as a method of allowing an investor to hedge currency exposure of international investments, previously a strategy not readily available to individual investors. With the decline of the dollar since the start of the year, FXE is up approximately 8 percent year-to-date. The ETF also is heavily traded, with over 1 million shares traded per day. The heavy volume and unique exposure makes this ETF a solid tool for an investor in gaining exposure to the currency markets. Rydex followed up FXE with the launch of several other currency ETFs with exposure to the Australian dollar, Canadian dollar, British pound, Mexican peso, Swedish krona and Swiss franc. These investments are similar to FXE in that they allow an investor to hedge exposure to the U.S. dollar. However, several of these funds have suffered from low-liquidity, making a trade more expensive due to a wide bid-ask spread often associated with low-liquidity stocks. For example, FXS (Swedish krona) trades a mere 12,000 shares a day and at the time of this writing and FXM (Mexican peso) is even less liquid, trading 5,000 shares a day. This illiquidity poses a problem to the investor wishing to add or remove dollar exposure without incurring significant bid-ask spread costs. Investors can currently buy ETFs that focus equities, fixed income, commodities, currency and many other narrowly defined sectors. While there seems to be no quick end to the glut ETF issuance any time soon (over 1,000 currently exist), the careful investor can weed through the wide varieties of ETFs available to add value in their portfolio. ---------- Christopher Raby is an analyst/portfolio manager for Karpus Investment Management. He can be reached at (585) 586-4680. Published: Thu, Apr 21, 2011