ETFs have come a long way in changing the investing landscape since the first one hit the market in 1993.
ETFs enable individual investors to engage in investing strategies that are more sophisticated than ever before. Many of these strategies wouldn't have been feasible from a practical standpoint 15 years ago for most investors.
"With the broad array of ETFs' investment guidelines, there are so many things that you can do with them now," says Ed McRedmond, Senior Vice President of portfolio strategies for Invesco PowerShares.
Betting on the Bears
For example, ETFs now make it much easier for an investor to take a bearish position or hedge against downside risk. An inverse ETF such as the
Short S&P 500 ProShares Fund
is designed to deliver a performance that is the opposite of the index that it tracks.
"In the past you would have had to buy protective puts or sell short," says Rich Romey, President of ETF Portfolio Solutions. "And if you went short, you had unlimited risk. Now with ETFs, your maximum possible loss is what you invest."
What if an investor is feeling generally bullish, but is wary of the prospects of a specific sector such as financials? Romey presents a strategy using ETFs to play off this sentiment.
"If you put $100,000 into an
-tracking ETF such as the
iShares S&P 500 Index
, but think financials will be a drag, you could then put an investment equal to one-half the weight of the financials -- or about $8,500 -- into the
UltraShort Financials ProShares Fund
," he says. "Because the fund returns twice the inverse of the financials, now you have effectively removed the financial piece from your holding."
PowerShares recently launched a series of actively managed ETFs that include the
PowerShares Active Low Duration Fund
PowerShares Active Mega Cap Fund
PowerShares Active AlphaQ Fund
PowerShares Active Alpha Multi-Cap Fund
XShares Advisors and
have also recently launched similar products.
Previously, investors who wanted a vehicle that coupled instant diversification with the skill of a portfolio manager would often look to mutual funds. Now, they have the option of utilizing actively-managed ETFs to accomplish this strategy.
"In the past, ETFs had to track an index," McRedmond says. "Now with actively-managed ETFs, there are more options for portfolio managers. This flexibility gives investors the opportunity to try to outperform benchmark indexes."
The evolution of ETFs has enabled investors to enter areas of the market, such as commodities and preferred equities, where access was limited in the past.
"We have seen a pretty good pickup in interest in preferred stock ETFs," McRedmond says.
Last year, his company introduced the
PowerShares Financial Preferred Fund
which has top holdings that include preferred classes of stock from
Royal Bank of Scotland
"It can be viewed as a less aggressive way to play the recovery of financials," he says. "It typically pays a monthly dividend that is viewed by the street as attractive for an investment grade portfolio."
iShares also has an ETF that is focused around preferred offerings. The
iShares S&P U.S. Preferred Stock Index
has a yield comparable to its PowerShares counterpart and has preferred classes of stock from
Freeport McMoRan Copper & Gold
among its top holdings.
Plays on the Dollar
The weakening of the U.S. dollar has captured its fair share of media coverage in 2008. The fluctuation has also drawn attention to ETFs that are plays on the dollar.
"I think that currency ETFs are going to be huge in the future," Romey says.
One currency ETF in particular that Romey finds attractive is the
PowerShares DB U.S. Dollar Index Bullish
"I think the worst is just about over for the dollar," he says.
Billy Fisher owns shares of Wachovia.