That new kid on the block with the monogram “ETF” isn’t just passing through town — the exchange-traded fund is here to stay. And what’s been hyped for three years as the next big thing in the hot ETF market, actively managed ETFs, may soon spark major change… Alongside the immensely popular passive ETFs that track indexes, there are currently trading at least 36 active ETFs, whose managers seek to outperform the indexes…
In a perfect world, passive and active ETFs will coexist. “There’s room for both,” says Charles Sizemore of Sizemore Capital Management, in Dallas, and editor of The Sizemore Investment Letter. “If you find a good manager, an active ETF can definitely add a couple of points to your return every year. But there will be times when passive index exposure — in bonds or stocks — is exactly what you want.”
But as efficient as ETFs are, if invested with imprudence or using inappropriate funds, the vehicle can backfire.
“An ETF is like a gun — in the right hands, it can be used effectively and efficiently. In the wrong hands, it can be deadly and lead to financial destruction,” Sizemore says. ETFs’ famed liquidity is double-edged. “The flip side to being able to get in and out of the market quickly is the tendency to overtrade, and that’s one of the biggest detriments to long-term investing success. Financial advisors get lured into it, and they do so at their own risk.”
Sizemore considers leveraged ETFs “more of a gambling tool that encourage Mom and Pop investors to take risks they can’t afford.”
Mostly, there’s plenty to cheer about in the ETF space; for example, the availability of emerging markets’ sector funds.
“They enable you to invest in emerging markets and also cherry-pick the sector you want to get into. So, for example, you can get direct exposure to emerging markets’ consumers,” says Sizemore. “Emerging Global Shares has a suite of ETFs that includes an emerging markets’ consumer ETF ($ECON).”
Though providers continue to bring out an endless parade of new ETFs, some may be suitable only for short-term trades: that is, if narrowly focused, they might be thinly traded and have little chance of longevity.
Sizemore once invested in a luxury goods ETF but, never attracting enough assets, the fund closed. In 2009, Stevens launched a family of faith-based ETFs — for the five largest Christian denominations in the U.S. — but FaithShares is now defunct too. “Not enough assets were gathered to make it profitable,” he says.
To read the article in its entirety, please see “The New Wave of Active ETFs.”