Frequently Asked Questions about ETFs
by ETFZone staff
Q: Where and how do I buy them?
Buy them as you would any stock, at any brokerage firm.
Q: Why would I buy an ETF when I can get an index mutual fund without a broker?
You can certainly buy a mutual fund directly from a fund group at no "load" or sales charge. Annual management fees will typically be higher with a traditional mutual fund and you can only buy or sell at the closing price at the end of the day.
Q: Why would I try to match the market with an index fund when I can beat it with an outperforming mutual fund?
First of all, the question presupposes that a mutual fund that has outperformed a market in the past will continue to do so in the future. Numerous studies by unbiased university researchers have shown clearly that mutual funds with leading performance records are just as likely to underperform than outperform the market several years into the future. Many investors have concluded that they are better off not taking the risk and instead remain happy with guaranteed average market returns of an index fund. Second, actively managed funds inevitably have higher annual management fees and have a worse capital gains tax profile.
Q: Are there any Dow Jones Industrials or S & P 500 ETFs?
Yes, there are numerous funds that track these and other popular indexes. Remember that Dow Jones and Standard & Poor's maintain their respective indexes, and that fund groups license the indexes so that more than one fund can end up tracking an index.
Q: Are ETFs guaranteed or insured?
There seems to be little risk of abuse of the ETF structure as an investment vehicle. In the US the Securities Exchange Commission thoroughly examines any application to create an ETF, and only large and closely watched firms are allowed in on the creation and redemption process of an ETF certificate. Finally, the same government agency (the Depository Trust Clearing Corporation) that ensures that individual stock certificates end up in the right investor's hands after a trade also ensures the ETF certificates are assigned correctly in a trade. In a decade of trading billions of dollars worth of ETFs, to our knowledge no US investor has ever lost money from fraudulent ETFs.
The risk of the underlying asset is quite another matter. Each asset class must be examined separately, and risk profiles of assets may change over time. Stocks are clearly risky, and ones in technology or emerging markets particularly so. Long-term bonds and real estate are also risky in their own way. Short-term investment grade bonds, however, have generally proven quite safe.
Q: Are ETFs only for stocks?
By no means. Any class of asset that has a published index around it and is liquid can be made into an ETF. Bonds, real estate are available now, and and gold ETFs are due in late 2003.
Q: Are there international ETFs?
There are many, including regional funds such as European or Pacific Rim funds, as well as individual country funds in relatively well-developed economies. In each of these countries there is an established index of reasonably large and liquid stocks that allows this to happen. As developing nations stabilize their stock markets, they will no doubt adopt ETFs.
Q: Do any ETFs try to beat the market?
Eventually there should be actively managed ETFs, but operationally it is much more difficult to manage. Applications to the SEC for such funds have been made but to date have not been successful. The problem is that an ETF is easier to create and redeem when all players in the process know exactly what basket of stocks will go into it. By its very nature, an actively managed fund must be secretive, because to reveal to the world what a stock fund is buying at the moment exposes it to parasitical traders who can jump in first and resell the stock to the eager fund. Various schemes have been proposed to circumvent these and other problems.
Q: Can non-US citizens own them?
ETFs are available in most developed nations. In the US, anyone who can open a brokerage account and buy stocks will be able to buy ETFs.
Q: Is it possible ETFs are just a fad?
This is not likely. As of July 2003 ETF assets in the US topped $155 Billion and are still growing in double digits, far faster than traditional mutual funds.
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