Watch Out for ETF Misinformation

I'm glad to share the job of helping you make sense of investing in exchange-traded funds, a mission made more necessary by the increasing interest and investment in these products. But I get concerned when I spot articles like the one I read over the long weekend.

I came across "You Might Be Surprised by What's in Your ETF" on SmartMoney.com, and I was negatively surprised by it, to put it mildly. While I do agree with the article's main thrust -- "know what you are holding" -- I believe the bulk of the piece's analysis revealed a fundamental lack of understanding of the product and even of the importance of forward-looking analysis.

Slippage on Oil ETF

The piece starts with a dissection of the United States Oil Fund(USO) that quickly goes off-point. Pointing out that USO doesn't own oil stocks and instead tracks West Texas intermediate crude, the author does well to emphasize that if you don't know what WTIC is, you shouldn't buy USO. He goes awry when he adds that you probably wouldn't want to buy it because it's down 32%.

Remember that USO is meant to track oil, period. If oil goes down, USO will go down; if oil goes up, well, you see where I'm headed. USO listed on the market in April when oil was much higher. USO is down a lot because WTIC is down a lot. Knowing that oil is down from its high is not enough information to make any decision about USO.

The piece would have done better to point out one problem with USO: The fund is badly lagging WTIC because of the oil market's contango, the cost of rolling to next month's futures contract when this month's expires, if next month's is more expensive, as is often the case.

Considering how big the contango issue has been for USO, you may not want to use it as an oil proxy if and when you believe crude will go higher. Making the decision about buying USO boils down to your opinion about what crude oil will do, whether USO will adequately capture what it will do and whether you even need this kind of exposure in your portfolio -- not just its past returns.

Get What You Pay For

The article then takes on the Claymore Ocean Tomo Patent ETF(OTP), which I profiled in December when it first listed. In that column, I posited that OTP could turn out to be a better mousetrap for large-cap growth based on its methodology and holdings. The SmartMoney article's author advocates knowing what's under any ETF's hood, but apparently he didn't check this one, because he misses what I believe is a pretty obvious point for an ETF, the difference a methodology can make.