Avoiding bad ETFs

I think that rise of exchange traded funds or ETFs is such an important trend that I devoted a whole chapter of my new book, Abnormal Returns: Winning Strategies From the Frontlines of the Investment Blogosphere to the topic. One thing I touch on in the book is how it is that the ETF world has been transformed over time. ETFs went from being pretty much an unmitigated good to now being much more a mixed bag. Investors therefore have to be much more selective in their approach to ETFs. In short, investors need to be able to tell the difference between a “good ETF” and a “bad ETF.”

Paul Britt at IndexUniverse weighs in on this topic and lists five criteria investors need to keep in mind to avoid bad ETFs.  Here is the list:

  1. Trading costs;
  2. High fees;
  3. Sloppy exposure;
  4. Other hazards, including small asset size.

The above reasons should be self-explanatory. Check out Britt’s piece to re-familiarize yourself with the arguments. In conclusion he notes that “there is no reason to pick a bad ETF.”

Karen DeMasters at Financial Adviser reviews a recent study that looks at “misleading ETFs.” Or ETFs whose fund name don’t necessarily describe accurately what is going on in the fund itself. This is especially a problem for novice investors who are not necessarily experienced or comfortable taking a deep dive into an ETF’s documents. DeMasters writes:

“Let the buyer beware.” According to Casey Research, that should be the mantra for some exchange-traded funds now on the market that have misleading names that don’t reflect their true makeup.

Casey Research issued a report that names funds it says are particularly misleading or require careful scrutiny before investing in it. The report, written by senior analyst Vedran Vuk, doesn’t necessarily conclude that the funds are bad and aren’t worth investing in; only that investors should read the fine print because a particular fund might not be what they think it is.

Take a look at the entire article for examples of funds that may not be what they appear on the surface. In short, investors need to “know what they own.” Just because comes in an ETF wrapper does not mean it is necessarily the best way to get exposure to a certain market or theme.

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