NEW YORK (TheStreet) -- A few days ago marked my five-year anniversary writing, mostly, about exchange traded funds for TheStreet.com and Real Money. When I started there was very little coverage of ETFs and nowhere near the breadth of product that exists today. In those five years there has been a lot of innovation, but ETPs -- P standing for products -- have become more complicated. Just as they create access and opportunity for investors, they also offer the risk of harming portfolios depending on how they are used.
On the positive side of the ledger are the various country, sector and niche ETFs created by providers such as
with their Market Vectors brand,
. Obviously industry heavyweights
have been active in creating products as well.
The recently ended decade shows why countries, sectors and niches (which are often concentrated in a sector or two) are important investment tools. The bear market from the start of the last decade originated in the tech sector, and the recent bear market originated in the financial sector. Both sectors went down far more than the broader market and offered warnings well ahead of time. In the case of tech, it grew to 30% of the
, and in the case of financials the inverted yield curve is usually a sign of trouble.
Anyone heeding those warnings could have used sector and niche funds to reduce exposure to the threatened sectors. Likewise, in the last decade as the S&P 500 was dropping 24%, Japan dropping 49% and the U.K. dropping 23%, countries such as Brazil, India and South Africa all had positive triple-digit returns -- and of course all of those countries can be accessed through ETFs.
To the extent you believe the U.S. will continue to be a relatively unattractive investment destination, along with some of the other larger foreign markets, specialized country access will continue to be very important in capturing normal or close-to-normal returns in the new decade.
Fixed income has come even further than equities; before about all that was available were a few Treasury bond ETFs. Now there are many funds for foreign bonds, emerging market bonds, TIPS, corporate bonds and even more esoteric funds, such as the
SPDR Barclays Capital Convertible Securities Fund
iPath US Treasury Flattener ETN
iPath US Treasury Steepener ETN
. The iPath funds, which listed just a couple of weeks ago, allow investors to speculate on the yield curve getting steeper.
The range of new products here offers genuine portfolio diversifiers to mostly speculative funds. Tools for speculation are not necessarily bad by any means, but things such as yield curve dynamics are a long way from plain-vanilla bond funds.
The popularity of commodities has of course led to demand for commodity related investment products, and the ETP industry has been happy to oblige with scores of related funds. Along the way, we have all come to learn much more about contango -- the condition where the expiring front-month futures contract needs to be rolled to a more expensive contract for the following month -- and the consequence it can have on investment returns.
This has been no more evident than with the
United States Oil Fund
which year-to-date is down 15%, compared with a drop of 3% for the generic crude oil contract. Does this mean the fund is not working correctly? No, it is working exactly as advertised; it owns the front-month contract for crude oil. To the extent the lag caught people off guard, and it did catch people off guard, it was because they did not fully understand the potential consequence of what contango can do. This has affected quite a few other funds, adversely and positively. This will be an issue for futures-related commodity funds; in addition to being mindful of the individual commodity, investors must also be cognizant of the roll yield of futures market.
Some investors think actively managed ETFs are a big deal, but I do not. From a bigger-picture standpoint they are not much different from closed-end funds or traditional mutual funds. The decision to buy boils down to faith that the manager will be able to repeat past performance.
In the past few weeks there have been some bigger problems with ETFs isolated as issues of increased correlation and questions about ETFs' role in the flash crash become more prevalent. One thing the financial crisis has taught us is that there are very often consequences in the future for actions taken today. This reasonably applies to the access and democratization ETFs offer. No product can be perfect or the single best tool for all parts of the market. ETFs are simply one tool available to investors to implement long-term investment policies and short-term trading strategies.
The next five years will again bring easy access to many "new" investment destinations and asset classes; five years ago there was no accessing Egypt or palladium, and in a few years we could have access to Kazakhstan and molybdenum. The next five years will also draw criticism to ETFs and more problems blamed on the funds. Just because we might be able to buy Sri Lanka or rhodium, for example, doesn't mean we should.
>To submit a news tip, send email:
Readers Also Like:
Follow TheStreet.com on
and become a fan on
At the time of publication, Nusbaum Roger Nusbaum had no positions in the securities mentioned, although positions may change at any time.
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;
to send him an email.