ETFs: Exchange traded funds are a hot investment

BY WARREN BOROSON

NEWJERSEYNEWSROOM.COM

BOROSON ON MONEY

I own an exchange traded fund called FXI, and if a smart cookie like me owns it, maybe you should consider ponying up for a few shares. Up 49 percent this year, up 118 percent over 5 years. Like almost all ETFs, it's an index fund, and in this case it buys all the stocks on the Hong Kong exchange. It's a bet on China. (iShares FTSE/Xinhua China 25 Index, NYSE.)

An ETF is an index fund that trades like a stock, not like a mutual fund. So you can buy or sell shares at any time of the day, not just after the close of trading at 4 p.m.

Mark Ukrainskyj, a Chartered Financial Analyst, spoke about the virtues of ETFs in a talk he gave recently to the Investors Club of the Ridgewood Hobbyists. Ukrainskyj is chief investment officer of the American Economic Planning Group, a private money-management firm in Watchung.

I myself wasn't there-one of my enduring goals is to get the hell out of New Jersey during winter-so I was cavorting about in Costa Rica, drinking beer, white-water rafting, and watching the toucans and caymans. Notes on the talk were taken by Jack Geraghty, who retired as a managing director from Harris Nesbitt's equity research department in 2003. He had been covering the semiconductor and semiconductor equipment industries since 1998.

Assets in ETFs, said Ukrainskyj, have shot up from $150 billion in 2003 to $776 billion in 2009 — more than five times as much. Sales are expected to to grow to $1,866 billion by 2013.

Some reasons for this stunning success:

The variety of choices (you can slice and dice the stock and bond markets any which way); and
the hideously poor performance of the mutual find industry during this last downturn.

The biggest providers of ETFs are Blackrock, State Street, and Vanguard, with a combined 84 percent of the whole market.

The single biggest ETF is the SPDR 500, representing the Standard & Poor's 500 Stock Index, with 11 percent of the market. Second is the SPDR Gold, with a 5 percent share. The top 10 ETFs have 39.2 percent of all the assets.

The biggest category is international with a 24 percent share. Fixed-income ETFs have 15 percent. Fixed-income ETFs have grown like Topsy in the last couple of years. (Does anyone know who Topsy was? Hint: Read "Uncle Tom's Cabin.")

The advantages of ETFs:

You can choose to have a specific industry, sector, or market exposure — from precious metals to health care stocks to an entire market.
It's easy to change your asset-allocation strategy — how much you have in stocks, bonds, and cash, or in value stocks, foreign stocks, and so forth.
You can readily diversify your portfolio, making sure you're not overly invested in any one area.
There's transparency of both the price and the holdings. In other words, you really know what you're buying — and for how much.
There's a tax advantages vs. mutual funds: ETFs don't have to distribute capital gains every year. So you can defer paying those taxes.

Alas, there are disadvantages, too.

You have to pay commissions whenever you buy or sell.
Market pricing — you can't take advantage of temporary bargains.
ETFs have a relatively short track record.
There's a limited menu of choices in some asset classes (like fixed income).

Ukrainskyj's advice:

Before you buy an ETFs, try to understand different index-weighting methods (market capitalization vs. price weighted vs. fundamentally weighted vs. equal weighted).
Make sure whatever company is behind the ETF has the size, scale, experience, and capability to do things right.

ETNs, by the way, look like ETFs but aren't. Exchange Traded Notes are actually the debt of an issuing company, where the "interest" tracks some underlying index.

Before joining AEPG in 1999, Ukrainskyj spent over four years as a securities analyst and portfolio manager at Capital Builders Advisory Services in New York. Before that he was a securities analyst at Amas Securities and a financial analyst on the chief investment officer's staff at Mutual of New York. He holds a B.S. in economics from the Wharton School of Business at the University of Pennsylvania and an MBA from the Haas School of Business at the University of California.

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