Monday, February 22, 2010

Felix Salmon Discusses ETFs

Felix Salmon of Reuters had a nice weekend column discussing some slight downsides to ETFs.  I posted here before that ETFs are overabundantly plugged (peddled) on the business TV and that I smelled a rat there because usually instruments that are over-recommended on TV are done so for commission purposes.  Looking back at that post here, I think maybe I was overly-cynical.  I do think sometimes ETFs can be a good choice, BUT I still am pessimistic on their general performance.  Of course the big advantage of ETFs is the lower fees you have in comparison with mutual funds.  And depending on which ones you choose, they do follow the market trends pretty closely.

Felix Salmon quotes a WSJ story by Ian Salisbury. Salisbury says that the average ETF underperformed its benchmark by 125bp.  "bp" for those of you not ingratiated with the terminology means basis points--bp. A basis point is 1/100 of 1 percent. so here 125 bp=125 basis point=1.25%.  Brokers and analysts   (in my opinion) make up this crappy terminology to convince people what they do is hard and you need to pay them fees, to do what you in reality could do better than they can.... but I digress.

Commodity ETFs can be risky, because they can be dumped quickly as Salmon has pointed out in past articles, such as he notes here with Gold ETFs.  Also small illiquid ETFs can be very risky in volatile markets.  Salmon puts the border line of safety in size for ETFs at roughly $10 billion.  So it's much better/safer to invest in the ETFs with greater than $10 billion outstanding.

Final Analysis: Whether ETFs or Mutual Funds are better is still up for debate.  Depends largely on fees and past performance (5 to 10 years) of that fund.  But the best of all worlds is choosing 15+ individual stocks from different industries with outstanding balance sheets, i.e., doing your own homework.

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