Another article, on the backtesting of ETF indices, tried to dissect the manner in which indices are put together and picked on the Guggenheim Solar ETF (TAN). The backtest "reflected a golden time for solar stocks," but the fund has been a miserable performer since being issued.
The reason for TAN's decline is not a flaw in the index design but lousy fundamentals facing the solar industry, as I outlined at The Street five years ago.
That said, the composition of the index underlying is simply another factor to be considered before investing.
The iShares MSCI Denmark Capped ETF (EDEN) is the only fund investing exclusively in Denmark. A U.S.-based investor wanting to own Denmark will either buy EDEN or an individual stock.Any decision about EDEN has to include an assessment of Novo Nordisk (NVO), which is a big player in the diabetes market. The stock has a 21% weighting in EDEN. It is not realistic that EDEN could do well if NVO were to do poorly. On the positive side for NVO, it is a sad fact that diabetes is becoming a growing problem all over the world, and NVO is a leader. On the negative side, as a drug company it is subject to FDA rulings, and it is only logical to expect other drug companies to devote a lot of R&D to competing more effectively in the diabetes drug market. If the threat of looming competition is enough to dissuade an investor from NVO, then EDEN becomes a poor choice and requires the investor to do research into other individual Danish stocks in order to gain exposure to that country. An exchange-traded product is merely an investment choice to go along with traditional mutual funds and individual issues. Just as there are ETFs with little or no investment merit so too are there traditional mutual funds -- such as inverse funds -- and individual stocks with little investment merit, but they still exist because the issuer perceives some level of demand. The top-down notion that products made for speculation should not exist for lack of investment merit is incorrect. A fund company that issues such an investment product is betting on demand of the market, and such a bet will either succeed or fail. From the bottom-up perspective of the end user, the investor, a fund built for speculation is either suitable for that end user or it isn't. If there were no ETFs, people would still have to avoid speculative stocks, speculative options strategies and even speculative bonds. At the time of publication, clients of Nusbaum's firm held shares of NVO. Follow @randomroger This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
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