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An Ever Increasing Number of ETFs

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Each year seems to bring an ever increasing number of new exchange traded funds (ETFs).

2011 was no exception.

Some say many of the new ETFs are not necessary, but I like the increase. 

Lots of New Funds in 2011

According to the recent SmartMoney article, “ETFs That Are New, But Not Improved” [4]:

From January through the fall, the $1 trillion ETF industry had unveiled 287 new funds — a rate of nearly one new one each day. That’s up 29 percent from all of 2010 and double the number that debuted in 2009.

As you can tell from the article’s title, SmartMoney is not enthusiastic about the number of new funds.

From my side, I like the greater offering.

Unless fund companies collude, a greater number of funds means more competition for my investment dollar. That translates into lower costs, allowing me to keep more of my capital for investing. Not making Barclays and the like wealthier.

And Lots of Variety

Funds continue to be creative in their offerings. As might be expected from increased competition.

Among the new additions are products geared to track the price of soybeans, German government bonds and even firms involved in the fishing business.

Now do I want to invest in soybeans, bunds, fishing, wind farms, and the like? Maybe not. In fact, investors can build strong, long-term portfolios without ever seeing a soybean or salmon.

But I do like having the option should I so desire.

Actually, I could invest in any of these asset subclasses without the need for an ETF.

But for small investors, investments of these types have tended to be difficult and/or expensive. Being able to invest through a fund is a more cost effective method for most.

But What About the Duds?

SmartMoney seems shocked that some of these funds have underperformed to date.

But what’s most surprising is that industry insiders don’t expect all of these products, or even many of them, to be successful. “They are throwing spaghetti against the wall to see if it will stick,” says Mariana Bush, who follows ETFs for Wells Fargo Advisors. “It usually doesn’t.”

For every successful ETF launch, though, there are several duds. PowerShares, which has more than 130 products, launched the Global Wind Energy ETF in 2008; that fund has lost two-thirds of its value and now has just $18 million invested in it.

Now, I disagree with the belief that fund creators do not expect “many of them, to be successful.” I do not know any product developers in any industry that say, “Hey, let’s create a product that will fail!” Not a recipe for success in the long-run.

Fund companies try to determine what their customers want and then deliver it on a cost-effective basis.

Sure, sometimes demand is not what was expected. But the same applies to many new offerings from very successful companies [5].

Not every new product can be a MacBook Air or iPad. But even Steve Jobs managed to come up with [6] such classics as the Pippin, USB mouse, G4 Cube, Mobile Me, Apple III, etc.

The Duds May Disappear

If you own a Blu-ray player [7], you are probably happy with your movie choices. But if you managed to purchase an HD DVD machine, you may not be as happy.

And if you invest in a successful ETF you may be happy. But if you select one of the duds, you may lose capital. And possibly the fund itself.

Individual investors should keep a look out for ETFs that don’t attract a large amount of money quickly, planners say. Not only are ETF companies manufacturing an increasing amount of new products, but they’ve also stepped up another process: killing off underperformers.

Good advice.

Always Do Your Due Diligence When Investing

That is why I typically recommend mutual funds and ETFs that have a track record.

Yes, they can fall in value and be bought out. But large funds with diverse holdings and a decent history often have less volatility than a small niche fund that was set up last month.

Large funds have the asset size to withstand short-term swings to a greater degree than smaller funds. Also, with greater capital, investors tend to be less jittery and not stampede for the exits when times are turbulent.

Consider the track record of the fund company as well as the fund itself.

How long has the company been in operation? What is its reputation and experience in developing funds? Does the company have a record of successful launches? Or does it close many funds? While Apple has its occasional glitches, better an Apple type fund company than one whose history emulates Gateway.

This is one of the reasons I like fund companies such as Vanguard. [8] They have a successful, long-term track record. Does that mean every new fund they offer will succeed? No. But my comfort level is higher than if my next door neighbour started up a soybean fund.

And for actively managed funds, make sure you look at the fund manager [9]. The person or persons making the day to day decisions on investments.

A fund may have a 20 year record of success. But if the fund manager for that 20 year period leaves and is replaced by my nephew, does that past performance mean anything going forward?

Always do proper due diligence on any investment you consider.

And whether that investment be in a fund or through equity or fixed income investment in a company, always consider management risk [10]. It is normally a key factor to assess.

It does not guarantee success. But it does improve the probability.

My One Concern About So Many ETFs

My concern on all the available ETFs is investor confusion.

With so many available choices, will investors lose their focus and invest in inappropriate products?

Maybe this is due to information overload. Too many options can cause uncertainty.

Or perhaps investors want to invest in sexy or exotic products. The shiny investment may seem more interesting (and potentially more profitable) than matte traditional ETFs. It is much more fun to discuss your investments in soybeans over morning coffee than to talk about those dull blue-chip, dividend bearing assets.

Investment Policy Statement

But these issues get more to developing and sticking to a proper Investment Policy Statement [11].

Not whether you get confused or distracted by a multitude of shiny objects.

You are intelligent investors, not crows.

If you maintain an Investment Policy Statement that reflects your unique situation, that should guide you through the investment maze.

For most investors, that means a core portfolio of basic ETFs to meet your asset allocation determination.

But at times, some investors may wish to augment their core holdings with other asset classes and subclasses. Perhaps for potentially higher expected short-term yields. Perhaps to better diversify the portfolio.

I like that there are many options that let me do this on a relatively cost-effective basis.

So keep the ETFs coming, please. The more the merrier.