There's an important lesson in the list of top-performing exchange-traded funds in August: Most of the big losers were winners not long ago.
The proliferation of ETFs has resulted in a smorgasbord of leveraged, "inverse" and inverse-leveraged securities. Built-in gearing virtually guarantees they will dominate performance lists. But when markets turn, as they always do, that same trait also assures they will fall to the bottom.
The overwhelming likelihood is that their occupancy of the top floors of the performance scroll will be brief. Chasing the gains of such funds will almost certainly turn out like buying tech stocks in 2000 or new homes half a decade later.
The perils of ETF "trend following" are brutally apparent in the extremes of performance tabulated in the two groupings of ETFs and ETNs in the table that follows. (ETNs are similar to ETFs except that their values are tied to financial notes rather than to stocks, bonds or commodities.) Listed directly below the quintet of winners are an equal number of favorites from recent months that have recently fallen hard from grace.
What should scare would-be "momentum" investors back to reality is that for each ETF/ETN on the list of standout performers in August, there is a corresponding fund on the losers list with reverse exposure in the same investment objective. The "mirror image" funds in the bottom list were all leaders not long ago.
Unless someone possesses world-class sector-timing skills, investing in such funds will destine the person to a life of ups and downs, with little to show in the way of index-beating long-term returns.
Of additional concern for many highly specialized ETFs such as those on the list should be their anemic volumes of trading. Whereas ETFs such as the
SPDR S&P 500 ETF
trade hundreds of millions of shares a day with average daily dollar volume in the billions, five of the funds on the list trade less than $1 million per day.
ETFs with low turnover of shares are susceptible to wide bid/ask spreads that result in relatively high effective transaction costs. In addition, market prices of low-volume funds are also prone to diverge from corresponding net asset values per share, again exposing buyers and sellers to additional trading costs.
Richard Widows is a senior financial analyst for TheStreet.com Ratings. Prior to joining TheStreet.com, Widows was senior product manager for quantitative analytics at Thomson Financial. After receiving an M.B.A. from Santa Clara University in California, his career included development of investment information systems at data firms, including the Lipper division of Reuters. His international experience includes assignments in the U.K. and East Asia.