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Investors Should Not Live by ETFs Alone

Investing in Brazil highlights another wrinkle in using ETFs for foreign exposure: ETF blinders. Would-be investors in Brazil have an ETF, CEF and several ADRs available to them. I can appreciate that Brazilian common stock may not be right for many people. For them, there are a couple of alternatives: an ETF, iShares Brazil (EWZ), and a CEF, The Brazil Fund (BZF).

The iShares Brazil has about 15 times the average daily volume of The Brazil Fund, yet The Brazil Fund has had better returns for one-, two- and five-year periods, has a slightly higher dividend yield and trades at a discount to net asset value. The Brazil Fund has a track record of better success than iShares Brazil (I realize this is backward-looking) but the ETF-only crowd would miss The Brazil Fund. Even if an investor still chose iShares Brazil, expanding the research process to include other types of products would lead to a more informed choice.

Managed ETF Products

Recently, several brokerage firms and banks have rolled out products that offer managed all-ETF portfolios to clients. I studied two, Ameritrade's Amerivest program and the Fidelity ETF Portfolio Builder, and found some significant disadvantages to them over just investing in ETFs outright.

In general, this group of products are computer-generated allocations of specific ETFs that attempt to capture a diversified portfolio. For most, investors complete a questionnaire that allows the program to establish an ETF portfolio based on risk tolerance and time horizon. The result will be a group of seven to 10 broad-based ETFs ranging from iShares S&P 500 (IVV) to iShares Russell 2000 (IWM) to iShares EAFE (EFA). But a computer-generated, automatically rebalanced portfolio that can assess only past performance of the ETFs in its stable of choices gives investors no forward-looking analysis, and that's a major negative.

What's more important, where the component ETFs have been or where they are going? Consider this simple analysis: Several strategists have said the next few years will offer below-average returns for U.S. equity markets. An investor who buys into this line of thinking may want to overweight dividends. That type of simple forward look hardly requires a CFA designation, yet a computer-run product can't offer even that much analysis.

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