No, there are not too many ETF’s!!!

By: ispeculatornew
Date posted: 07.20.2010 (5:00 am) | Write a Comment  (4 Comments)

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It’s crazy and almost makes me angry. Last week, my wife had cut out an article in our local newspaper where the journalist argued that the explosion of ETF’s was useless, confusing, dangerous and even perhaps an immoral attempt for the financial industry to make more commissions. I think this guy, like many others is confused about the role of ETF’s, how they can and should be used depending on the investor type and specific profile.

Just how many ETF’s are there?

This number changes every day of course as some of them open while others are closed. But there are a few more than 1000 ETF’s right now traded in US markets in a large variety of asset and subasset classes. Any trader can get involved in small or large caps, real estate (REIT), bonds, gold, oil, other commodities and many many more. I hope you noticed the distinction though, I said CAN not MUST.

Why are there over 1000 ETF’s?

The answer to this is very simple. Supply is provided for demand. No ETF issuer will create a Uranium ETF if there is no clear demand. There are high costs associated with issuing and creating ETF’s, it’s not the lemonade stand experiment that you can take down in a few minutes, far from it. There are investors interested in specific exposures and it can be cheaper and more effective to do so through ETF’s. So no, I don’t know how someone could argue that an ETF is useless. They can be used for hedging or speculation purposes. If an ETF is created and there is no demand for it, it will end up closing and costing a lot of money to the issuer, just like any other product. Not all investing is for passive, retirement purposes. Important flows are used for more active investing where these ETF’s are often a perfect fit.

How many ETF’s does Joe the plumber need?

Here is where the confusion often comes from. While I think that 1000 ETF’s is NOT too much, I would also argue that most investors can build a solid, efficient and cheap portfolio with less than 10 ETF’s. I had wrote about fixed income ETF’s and how you could have a solid portfolio with 3 to 5 ETF’s. The same could easily be done with equities.

I don’t think anyone could argue this honestly. Regular investors should have a simple and effective retirement portfolio that relies more on passive (index) investing. But for those who can afford to have another more agressive portfolio with specific investments, it is more than possible that investing in more specialised ETF’s would be a better fit.

If you have an investor who strongly believes that the price of gold will increase, it is now very easy to make an invesment based on that theory. It used to be a lot more complex before such specialised ETF’s existed as the investor would have needed to open a futures account, post collateral and trade in a more complex and volatile environment.

Not fraudulent

The theory of this journalist was that these ETF’s were being created to create commissions for brokers. How? More ETF’s would mean more trades and more commissions being paid out. This is complete nonsense.

1-There are almost no cases where an ETF issuer is also associated with a broker and so this relationship almost never exists. In the rare instances where it does, the issuerbroker has used the relationship to provide free commissions on the ETF’s. Not exactly fraud is it? Charles Schwab is one such example.

2-There are already thousands of stocks. If a broker wants to make “useless” trades in order to generate more commissions, there is no need to use ETF’s and using them does not make it look any better.

3-Actually the most abuse is taking place when financial advisorsbrokers are purchasing mutual funds instead of ETF’s for their wealthy clients. These clients end up paying almost 1% more of annual fees but the brokeradvisor gets trailor fees or a portion of that additional commission.

So when looking for abuse and fraud, look in other places first as ETF’s remain a very attractive choice and even if thousands more are created, that is not a problem in itself but rather an opportunity for the right investors.

Do you agree? Or do you think there are too many ETF’s? If so, would you agree that the free market will settle things in the end or do you think regulation is required?

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4 Comments

  1. Comment by Zavi — July 20, 2010 @ 8:34 am

    hahaha I think it’s an interesting debate. There are many ETFs that investors can choose from. It’s just that investors have to be careful on choosing because some are struggling or not fully understood (i.e. leveraged ETFs).

  2. Comment by The Financial Blogger — July 20, 2010 @ 9:44 am

    I think there are too many ETF’s when Joe The Plumber thinks he can handle his investments.

    Most of the time, people will trade whatever index they saw on TV ;-).

    Diversification is good, now we have reach the point of diworsification 😉

  3. Comment by IS — July 20, 2010 @ 5:20 pm

    @ Zavi – absolutely and I can imagine the day where additional forms are needed to trade those like trading options, nothing wrong with that

    @TFB – ok but then it’s probably even much worse for mutual funds right? They have at least 10x more mutual funds than ETF’s and they have bigger marketing budgets thanks to those big fees….

  4. […] they give almost unlimited possibilities. I know some investors believe that there are too many ETFs but frankly, I don’t see a problem with that, far from it. Lacking options is a problem. […]

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