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New ETFs Can Serve as Caution Signs

Richard Widows

There's something you need to know about that shiny new exchange-traded fund that just launched. Historical evidence suggests you might be better off dumping your investments in that fund's entire sector rather than jumping feet first into that "can't miss" ETF.

Now that there are more than 800 of these investment vehicles available in the U.S. market, management firms are having to dig ever deeper into their inventories of creativity to come up with new concepts to add to their ETF offerings. The bold minds who determined there was an absolute need for ETFs in the areas of "metabolic endocrine disorders" and "dermatology and wound care" investments now have to reach even further for new product concepts. (And in case you were wondering, the HealthShares Metabolic Endocrine Disorders ETF and the HealthShares Dermatology and Wound Care ETF were humanely euthanized some time ago.)

The lag between the emergence of a new investment trend and the time it takes to gain enough validity to convince the ETF industry that it merits a new vehicle can seem interminable. When you factor in the time it takes to design and construction a new ETF offering plus the lengthy registration, approval and listing process, the concept for that fund could easily be at its peak -- or even over the hill -- before the PR machine even begins advertising the fund as the hot place to invest your cash.

There are many notable exceptions, but all too often an ETF's debut coincides with the moment when investors should be starting to think about taking profits in the area of the fund's focus.

As is evident in the table below, this isn't a new phenomenon. In 1966, the incipient ETF industry was bolstered by the addition of a quartet of Asian funds. Just 16 months later, Asian currencies nosedived and stock prices throughout the region collapsed, kneecapping investors with double-barreled blasts.

Then, in 1999 and 2000, as the technology/telecom frenzy approached its zenith, the ETF industry accommodated investor thirst for funds targeting that sector with an array of offerings -- just in time for the tech bubble to burst.

At one time, BRIC -- with stands for four markets, emerging powerhouse Brazil, resource-rich Russia, outsource-destination India and manufacturer-to-the-world China -- may have seemed like investment nirvana. Geographically and economically diverse and growing rapidly, a BRIC investment couldn't miss, or so it seemed. But not many months after the introduction of two BRIC ETFs, that investment area joined the rest of the market in a downward spiral.

More recently, the fund industry accommodated the ascending popularity of the financial, housing and emerging markets by offering an array of new ETFs in those sectors -- not long before each collapsed. The table below offers a sampling of examples.