All About Exchange Traded Funds (ETF) Part II

By : Andrew Shultz    99 or more times read
Submitted 2010-01-30 15:48:40
The biggest drawback for ETFs is transaction costs. The only way to buy or sell an ETF is via a broker — and for fast-fingered traders, the costs can add up. That's why fans of dollar-cost averaging might find ETFs to be a pricey endeavor. If you're willing to handle the trading cost and manage your own online trading through a discount online broker, this may not be as big of an issue.

In terms of net assets, Standard & Poor's Depositary Receipts (SPY), or Spiders, are by far the biggest ETFs. Launched in 1993 by State Street Global Advisors, they now boast more than $41 billion in assets (as of Apr. 2, 2004). Next come the Nasdaq-100 Index Tracking Stock (QQQQ), commonly referred to as Qubes.

One of the greatest advantages of ETFs is the ability to allow broad-based index products. especially appealing to buy-and-hold investors. More-active traders might consider sector-based ETFs. For example, Energy sector has been real hot with crude oil prices touching $100/b. If you have no clue what stock you need to own to get benefit from energy sector, you can just go out and purchase an energy ETF. For those who want to add some real estate to their portfolios, a real estate investment trust ETF might be a prudent move. A health care professional with large holdings of health care stocks might buy a put option on a health care sector ETF to minimize risk.

Final Verdict
As financial markets become more mature and get more active participation from individual investors, there will be a much broader selection of ETF offerings in the U.S. Products that track commodities, currencies or even gold ETFs. And ETFs that track crude oil or nonferrous metals could start cropping up too. As ETF offerings blossom, investors will surely call on increasingly sophisticated strategies to exploit them. Hedge funds will likely be the pioneers. Right now, most of them use ETFs both to maximize gains and to minimize risk. A common tactic is to play a single stock off its industry group. Say a hedge-fund manager thinks CSCO will outperform its peers. He'd buy CISCO (CSCO) and short-sell an ETF that tracks the networking sector. The same sort of long/short strategy can be executed with put and call options as well. And that's just the beginning.

In the fixed-income arena, the benefits of ETFs are even clearer. The performance difference between similar bonds typically isn't all that large; usually, it comes down to transaction fees. Buying a single fixed-income ETF is more cost-efficient — and is far easier — than laddering different notes of varying maturities. In a rising interest-rate environment, bonds of shorter durations are generally the vehicle of choice. The idea is to hold short-maturity bonds so that when interest rates rise, new bonds with higher coupons can be purchased. If investors are locked into longer-maturity bonds, they'll be at a disadvantage when rates rise and bonds with higher coupons are offered: Not only will their money be earning less than it could, but buyers for bonds offering lesser coupons are often scarce. So experts say the name of the game now is to go short-duration.

Remember, purchasing shorter-maturity bonds in a low-cost way plays perfectly into ETFs' strengths because the shorter the bond duration, the more efficient the market tends to be. So using an actively managed short-term bond fund is less necessary than, say, a managed fund for municipals or high-yield bonds, which have less efficient markets. If you agree with the prevailing view that the next move for interest rates is higher, purchasing shorter-duration fixed-income ETFs can provide bond exposure and minimize interest-rate risk. An even more aggressive play is to short-sell a longer-maturity ETF, such as iShares Lehman 20+ Year Treasury Bond Fund (TLT). Typically, the longer the bond duration, the greater the price movement. So shorting longer-duration bonds in a rising interest-rate environment can translate into greater gains for investors. But this obviously carries more risk.

Increasingly, fixed-income ETFs also are being used as alternatives to money markets, experts say. With money-market funds offering paltry yields, investors can squeeze out better returns by assuming a bit more risk with shorter-duration fixed-income ETFs. Consider that the iShares Lehman 1-3 Year Treasury Bond Fund (SHY) carries a yield of 1.75%, far surpassing the average taxable money-market yield of 0.50%. While bonds may not seem sexy, fixed-income ETFs can add just the right amount of spice to a portfolio.



Author Resource:-
Article From Fiscalwealth | Personal Finances, Investment and Wealth Management

| More