How much do you know about exchange-traded funds?If you're a regular reader of this column, you probably know more than most people. But because fewer than half the investors who own mutual funds understand the difference between these products and ETFs, that's not necessarily saying much. According to a new study by Rydex Investments, 38% of all mutual fund investors don't even know what an ETF is. It's a startling statistic, considering that these investment vehicles have been around for 14 years. ETFs are baskets of securities that combine the benefits of an index mutual fund with stocklike trading features. Like mutual funds, ETFs allow you to invest in a pool of securities in a single transaction. And similar to stocks, they are listed on an exchange and can be traded throughout the day, bought on margin or sold short. By comparison, open-end mutual funds are issued and redeemed by their sponsors just once a day, at the market's closing price. These products are already a big hit with institutional investors, who account for the bulk of trading. Now the ETF industry is making a bigger push to get the attention of individual investors. Ads for ETFs have popped up during football games and in the New York City subway system. While it's not unusual to see ETF ads in personal finance magazines, they are also appearing in more broad-based publications, such as The New Yorker.
In this vein, Rydex has launched an education program, dubbed ETF Essentials, designed to explain the complexities of ETFs in simple, understandable language. Unlike some of the industry's print and TV ads, Rydex's campaign is designed to reach individual investors primarily through their investment advisers and stock brokers. Not that the industry is suffering. So far this year, 215 new ETFs have been launched, bringing the total to 596. According to a Morgan Stanley report published last month, the number of investors using ETFs surged 1,242% over the past nine years, with more than 2,200 institutions worldwide using one or more ETFs. On the year through Sept. 10, the worldwide 20-day average daily trading volume increased 252% to $86.5 billion, up from $24.6 billion at the end of 2006. Still, retail investors are relatively minor players. Rydex's survey found that only 20% of mutual fund investors own ETFs. About 63% don't know enough about ETFs to invest in them and 55% don't even know how to buy them. Still, 51% said they would consider buying ETFs if their financial adviser suggested it. And that's what Rydex is hoping to achieve -- getting more financial advisers to promote ETFs. The Rockville, Md., company is a relatively small player itself, with a market share of roughly 4%. It offers 17 ETFs, such as the S&P 500 Pure Growth ( RPG), S&P 500 Pure Value ( RPV) and a collection of equal-weighted sector ETFs like the S&P Equal Weight Energy ETF ( RYE).
Rydex also offers eight exchange-traded products called Currency Shares that allow investors to bet on the direction of exchange rates, such as the Euro Trust ( FXE)and the Canadian Dollar Trust ( FXC). Unlike ETFs, which hold stocks or bonds, these ETPs are grantor trusts that hold the actual currency. "ETF Essentials," an information packet you can request from your investment adviser, is an easy, straightforward explanation of how ETFs work and how they can be used in your portfolio. In addition to listing their benefits and comparing them to mutual funds, "ETF Essentials" explains how ETF shares are created, how their liquidity can be affected by the underlying securities and a how arbitrage plays an important role in pricing the shares. Much of the same information is also available on Rydex's
website. There are plenty of other resources on the Internet that you may also want to check out, such as ETFConnect.com, which provides snapshots of both ETFs and closed-end funds and lets you screen and compare them based on specific criteria. The site is sponsored by Nuveen Investments ( NUV) An independent Web site, ETFGuide.com , also explains how ETFs work and provides news, commentary on the industry, model portfolios and quarterly surveys tracking the average expense ratios of various ETF categories. There's also ExchangeTradedFunds.com, which provides educational materials, news and commentary along with one of the best resources for information on the international ETF marketplace.