What are ETFs? Should they be in your Portfolio?
ArborInvestmentPlanner.com
April 2009
Special Report
What Are ETFs?
Should They Be In Your Portfolio?
ETF stands for Exchange Traded Fund. Used as an investment vehicle, they are a hybrid of mutual funds, stocks, and closed-end mutual funds. Like stocks or closed-end mutual funds, ETFs trade on a market exchange so they can be traded (intraday) anytime stocks trade, not just at the end of the day. It has multiple holdings or investments inside it like a mutual fund or closed-end fund. It has a certain number of shares outstanding on a given day that investors buy or sell to change their position, like a stock or closed-end fund. But unlike closed-end funds which can trade at a discount or premium to their NAV (Net Asset Value), ETFs typically trade close to their NAV because they can be exchanged in-kind with baskets of the underlying securities by authorized institutions.
The ability to trade intra-day may or may not be important in an individual investor, but it definitely is a nice feature. The ability to have multiple holdings or track a specific index is a major positive attribute since diversification is so important. The fact that ETFs have shares outstanding and don’t have to liquidate small amounts protects shareholders because fund managers are not forced to liquidate assets on demand that drive up commissions and fund expenses.
In addition to the above, ETFs have other important attributes. ETFs generally have lower expenses ratios than mutual funds due to the way they are structured. Like sector mutual funds ETFs can segment to very specific or targeted sectors of the economy. This allows investors to have a diversified position in a small slice of a sector you want to be invested in. For example, ArborInvestmentPlanner.com believes potable water is going to be a scarce resource this century. There are few pure water plays or opportunities in individual stocks, but you can buy ETFs that specialize in companies in the water industry. This allows you to take a small position that is diversified.
While there are many positive attributes to ETFs, there is one major drawback. Since most ETFs are not actively managed, but are programmed to follow a specific index, the index and therefore the EFT, may not own the very best stocks. Actively managed ETFs will generally have higher expense ratios than ETFs tied to an index. This is why it’s important to either do your own homework or have someone you trust such as ArborInvestmentPlanner.com doing your research for you.
Like any investment, ETFs require research and knowledge to be able to place them in a properly diversified asset allocated portfolio. ETFs play an important role in the Arbor Asset Allocation Model Portfolio (AAAMP) by providing an inexpensive way to diversify small positions in targeted sectors of the market (i.e. Water Resources, Precious Metals Mining, Agribusiness, Environmental Services, Biotechnology, etc). The Arbor Asset Allocation Model Portfolio (AAAMP) usually holds 25-40 individual positions of which typically about one-third are ETFs.
More information is available at www.ArborInvestmentPlanner.com.
Sincerely
Ken Faulkenberry
ArborInvestmentPlanner.com
