By Mike Caggeso
It's no coincidence that the rising popularity of exchange-traded fund (ETF) investing coincided with the rise of investor-empowering online-trading platforms such as E*Trade.
It was the mid-to-late 1990s, and the Internet's new inroads to Wall Street were stirring a new confidence in investors. But these eager new traders didn't have the time or experience to pour through mountains of statistics and analysis like full-time brokers.
Also at the same time, the markets began to open, allowing Wall Street firms access to overseas stocks that were previously hands off, said Horacio R. Marquez, a Money Morning contributing editor and an emerging-markets specialist.
Enter ETFs, index-tracking funds that can be bought and sold like stocks. Many times, ETFs represent a group of related stocks – such as agriculture or commodities – or stocks from another country that investors couldn't normally buy individually.
For example, Brazil's top-rated ETF, iShares MSCI Brazil Index (EWZ), is a pool of Brazilian stocks that aims to parallel the performance of the country's publicly traded securities.
Among their advantages, ETFs trade like stocks during the day and they don't require a ton of money.
"Another advantage of doing that is you're not hit with an unexpected loss in just one of the stocks," Marquez said. "ETFs allow you to focus your strategy on the most important component of profits, which is asset allocation."
Three Key Elements
In 1993, Standard & Poor's launched the first ETF, called S&P's Depository Receipts (SPDRs). Today, its bread-and-butter ETF [and biggest ETF by size], SPDR S&P 500 (SPY), seeks to correspond generally to the price and yield performance of the S&P 500 Index.
As of January, there were 1,173 ETFs listed on exchanges in the United States, Latin America, Europe, Asia, Australia and South Africa. A Middle East ETF is expected to launch later this year.
The range which ETFs encompass is remarkable. ETFs are available for nearly every sector – from Nuclear Energy, Financials, Health Care, Utilities, Aerospace & Defense, Real Estate, etc.
The menu of commodity-specific ETFs includes gold, silver, platinum, steel, petroleum and more.
To say investors have a plethora of choices in an understatement. But the sheer variety of ETFs can confuse the good with the bad.
Marquez offers three pointers to picking winners:
- Look for ETFs that replicate the index they are supposed to follow. "For that to happen, they have to trade in liquid markets," he said. If the market's illiquid, the ETF will trail as the market rises and follows, which in turn skims profits.
- Look for ETFs run by the top fund families, such as Barclays, Vanguard and State Street Corp. (STT).
- Most importantly, as mentioned earlier, the best ETFs offer asset allocation but also in the right country or sector. Just ask investors who own streetTRACKS Gold Trust ETF (GLD), which has gained more than 49% in the past year on the back of gold's meteoric rise.
The Best of the Best
However, prospective ETF investors don't have to look too far to find value. Among the best-selling ETFs are a handful that have a history of solid performance and/or bright prospects over the short, medium and long term.
Marquez first mentioned financial ETFs, such as Financial Select Sector SPDR (XLF), whose trading prices have cratered from liquidity and credit crunches.
"The situation is going to turn around, not only recover but thrive. Most of the losses are behind us and these are the companies to buy for the medium and long-term," Marquez said. "But if you expected to get rich tomorrow, then forget about it."
Oil-targeting ETFs, such as Oil Service HOLDRs (OIH), serve to gain as the price of crude is expected to rocket even higher this year.
Perhaps the most intriguing are emerging market ETFs that reflect the gains of another country's stock index:
- Brazil: iShares MSCI Brazil Index (EWZ)
- Russia: Market Vector Russia ETF Trust (RSX)
- India: Wisdomtree's India ETF (EPI)
- China: iShares FTSE/Xinhua China 25 Index ETF (FXI)
Claymore's BRIC ETF (EEB) averages the stock market gains of all the above emerging markets, collectively referred to as BRIC.
Or more broadly, iShares MSCI Emerging Markets Index ETF (EEM) aims to capture 85% of the (publicly available) total market capitalization of overall emerging market stock performance.
News and Related Story Links:
- Money Morning:
Middle East ETFs Will be Available "This Year"