Doc2 has touched on an issue being discussed within the ETF industry. As more ETFs roll out (300 + expected this year) uneducated investors tend to group them all together as the same. In fact this is far from reality. We believe that ETFs should be called ETP’s (Exchange Traded Products) as a whole. This has already being done within the industry. Then subcategories could be added so that ETFs that hold real assets are called ETFs. Maybe they could call current ETFs that use leverage ETL’s? ETFs that currently trade only futures something else… and so on. This would make it much easier to distinguish the difference from the surface. Today’s reality is that you must understand structure to fully know what your invested in. Here at our firm we believe this understanding falls well within our fiduciary standard to our clients. Large brokerage houses generally have someone with ETF knowledge creating a list for their salesmen (advisor) to use with their clients.
Doc2 has made some very common yet incorrect mistakes in his comment above. ETFs under the 1940 act are in no way shape or form derivatives. This is where CNBC got it wrong also, thus the purpose of this blog post. Under the 1940 Act, if you buy an ETF you own the underlying holdings. If you own 50K shares of the ETF then you have the option of exchanging the shares for the underlying holdings. If you do not have 50K shares, you own part of the 50K share bloc. This block is not owned by the market maker as Doc states, but is held in trust separate from the fund company and the market maker. Clients do have a right to this partial share in cash form, just not to receive the actual stocks. Why would you anyway? Imagine the trading cost to sell 500 companies on the S&P 500 with just a 10k investment! Just sell the ETF in one transaction.
ETFs do get their value from the underlying holdings. This value can be tracked by adding a few symbols to an ETF. For example IVV, the S&P 500; If you want to know the net asset value, go to yahoo finance and enter the ticker ^ivv-iv. This will give you a 15 second quote of all the underlying holdings. It is true that ETFs can and will trade away from these values, but there are market makers in the market looking for arbitrage opportunities which push the prices back to NAV. If an ETF is trading far away from NAV there are several ways to still get the ETF at or very close to NAV. Experience and a good ETF education can save clients a significant amount in trading costs (errors) IF done properly.
ETFs created within the 1933 Act will many times not own the underlying instruments. Most individual investors should not and will not own these types of ETFs. iShares and Vanguard, two of the largest providers of ETFs only have a small number of 1933 Act ETFs.
There are a lot more facts to cover but this is the basics. Keep Cost Low, Maintain a Diversified Portfolio, Invest for the Long Term
