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Off the Mark on ETFs

Also coming under fire from Herb were niche equity funds, specifically the Global X Lithium ETF (LIT). This fund owns mostly materials stocks in a narrow segment of the market. The fund is neither good nor bad; it is a plain vanilla proxy for an investing theme and yet another choice to add to a short list of individual stocks.

LIT is not the tail wagging the lithium industry dog as alleged by Herb. LIT trades 40,000 shares per day or about $600,000 in dollar volume. Sociedad Quimica Y Minera, FMC (FMC - Get Report) and Rockwood Holdings (ROC) combine to make up 50% of the fund and each stock trades many times that dollar figure.

What about wagging the dog of some of the smaller holding like Reed Resources which is about 2% of LIT and small cap stock in Australia? Based on the average trading volume of LIT, the ETF would account for $12000 worth of Reed (2% of $600,000) compared to a dollar volume on the ASX of $100,000.

It is possible that any ETF where three stocks comprise such a large portion of the fund is not a suitable investment for certain investors. That is a good question for anyone interested in the lithium space but is not a reason to outlaw the fund and it still takes less single-stock risk by definition.

Investors have always misused investment products. Options and margin accounts used to get more notoriety in this regard but now it is more popular to vilify ETFs. If we got rid of ETFs today, then the greed factor that leads to misusing a product will emerge in some other product because there will always be some segment of the investing public trying to exploit what they believe is their edge and many of those folks will simply be wrong.

At the time of publication, Nusbaum nor his clients did not have a position in any of the equities mentioned.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback; click here to send him an email.

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