An increasingly important investment vehicle for many advisors looking to capture all or part of the market while keeping expenses to a minimum has been exchange-traded funds (ETFs). While originally created as an efficient alternative to equity index mutual funds, advisors can now also steer their clients' money into currency, commodity, real estate, and bond ETFs.
To get a handle on what's happening in the world of ETFs--where assets grew 40% in 2006 to $422 billion, according to the ICI, Managing Editor Bob Keane chatted with Tim Meyer, ETF business manager for Rydex Investments, in February.
What should advisors consider when they're looking at ETFs?
They should be looking at how the underlying index is constructed. There are now over 300 ETFs, and [they use] a lot of different benchmarks and methodologies. Our initial product was equal-weighted to the S&P 500 and what that offered for advisors was better diversification and the elimination of the single-stock risk. That's really gone over well in the advisor community because it's a story that's easy to understand. It still gives access to the S&P 500 and allows further product diversification.
At a glance, many ETFs look the same. How can an advisor be sure she's chosen the right one?
Many exchange-traded funds are cap weighted. So they do tend to look alike, though they'll have different nuances according to the methodology that the underlying index provider supports. In regard to a client's account, what an advisor would like to do is to make sure, based on the risk characteristics of the client, that they are putting them in a well-diversified, broad-based portfolio of exchange-traded funds. That goes beyond even diversification among ETFs themselves. It also looks at alternative exchange traded funds where the non-correlation to the U.S. equity markets could help support their overall portfolio. Examples include CurrencyShares [Rydex's seven currency ETFs], commodity ETFs, or fixed-income ETFs, along with some of the newer fundamentally weighted or equally weighted products.
What are the next types of ETFs?
We're going to be seeing an expansion of getting access to new markets that you couldn't get in the past. That's what currencies offer, that's what commodities offer. We'll continue to have product of that nature.
What impact will the growth of ETFs have on other investment vehicles, like mutual funds?
Between studies that we've seen and the internal growth of our own products, there's not been a lot of cannibalization of the mutual fund business. There've been a lot of opportunities where you see stock-only advisors who want access to, say, a certain sector, they'll use an ETF rather than using single stocks. However, there continues to be an expansion of products, so advisors are starting to have more choices in ETFs and a lot of new money coming in is going to ETFs versus mutual funds. Funds are still growing at a faster dollar amount, but not at a faster percentage.