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TheStreet Open House

Cramer's Got It Wrong on ETFs

Jim Cramer has an interesting video called "Cramer Says ETFs Don't Make Any Sense."

Jim makes a couple of points I agree with and a couple I don't. One big issue for him is that ETFs simply represent the creation of product by Wall Street to be sold to an unsuspecting public. That new product is a big source of revenue. While new products do bring revenue to firms like Merrill Lynch and Morgan Stanley, ETFs are not part of that game. Big investment banks are not part of the process of listing an ETF.

The revenue comes from delivering a successful product that draws investor interest and assets. Revenue comes from ongoing management fees, not the mere listing, as is the case with closed-end funds or common stocks. From the fund provider's viewpoint, more revenue comes from a product that draws ever-more assets that pay the expense fee in perpetuity.

In Jim's video, he talks about ETFs as being anti-diversification and draws a parallel to owning tech stocks from different subsectors and thinking you're diversified. I watched that part of the video three times, and I still am not clear on what he meant. That part of his argument seemed to focus more on investor behavior as opposed to the structural elements of ETFs.

Jim believes that you end up clustered. If you are clustered, it has nothing to do with the product. The S&P 500 has 10 sectors. The way I build portfolios (and I doubt this is unique) is to look at the weight of each of the 10 sectors, decide how true to the current weights I want to be and, finally, find the best way to build each sector.

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