Wednesday, September 21, 2011

ETF soup – time bombs

ETFs are quickly becoming a morass of obfuscation. In the Financial Post of September 20, Jonathan Chevreau writes about creating an entire risk hedged portfolio from ETFs that represent a wide range of asset classes including corporate bonds, commodities, REITs and of course normal stock market indexes. The reason for all these different ETFs that are currently flooding the Canadian investment world is obvious: profits! Profits for the issuing companies that is.

In addition to iShares and Claymore, we now can also buy ETFs from many of the banks, Horizons BetaPro, PowerShares Canada, and First Asset Management; just to mention a few. The new idea is to create not only a diversified stock portfolio but a diversified investment portfolio of ETFs comprising asset classes that do not ‘correlate well’. That is, when one asset class rises in value another may fall or does not change. Asset classes that correlate perfectly have a correlation of 1.0 and those that act exactly the opposite have a correlation of -1.0  (minus 1.0). A portfolio of assets that does not correlate well provides protection against price volatility. Of course, building on people’s greed, the next step would NOT be a diversified portfolio with less volatility. Instead, now you can buy higher risk investments with less volatility and a higher return… yeah right!

ETFs are not-actively managed and some discount brokers do not even charge a commission when buying or selling them. You may wonder how then do these brokers make money? Well, one of Jonathan’s concluding remarks may shed light on this: “I’d say 99.9% of retail investors will need professional help pulling this all off. Try going it alone and DIY will end up meaning ‘do it TO yourself’”.

My take is to stay away from this stuff. Only use simple ETF’s such as discussed earlier on this blog. Make sure, your ETFs are not derivatives but that they actually own the assets. For example, when buying a Gold ETF make sure it really owns the gold bullion. When buying an ETF representing the Dow Jones, make sure it owns the underlying stocks not some options.

In today’s markets it is hard for the money types to make money; so they’re dreaming up any scheme to make a living - usually at your expense! With every new twist they’re trying to convince you to give them your money. Now ask why that is? Because they don’t have it themselves! ETFs these days are quickly becoming a mishmash of derivatives that can only be understood by the ‘experts’ just like structured investment vehicles, default swaps and subprime mortgages. Remember how Warren Buffett sees derivatives: “I view derivatives as time bombs, both for the parties that deal in them and the economic system

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