Saturday, February 02, 2008

ETFs, Indexation Threaten Mutual, Hedge Funds: Michael R. Sesit (Bloomberg)

It's interesting every now and then to see what really are the primary questions facing investors grappled with in the mainstream financial media commentary, which is usually so fixated on the latest financial markets "noise". Here's a little commentary of my own. It's helpful article and a good read. A link is below.

The article is generally right on. Quibbles? Yes, I have a few. Sesit refers to ETFs as an "asset class". No. No. No. ETFs are no more an asset class than open end mutual funds are, despite the dumb pie chart you see each month on your brokerage statement! They are a financial investing vehicle which can be used to invest in one or more particular asset classes, i.e., US large-cap stocks, emerging market stocks, various types and duration ranges of bonds, or also quite usefully, investment "styles" in a particular asset class, such as US small-cap value stocks, or even economic sectors, such as consumer durables companies.

More recently, the field has widened to include more diverse approaches, still useful and well worthy of acceptance, such as the "fundamental indexing" approach used by WisdomTree. But it's come to the point that you can get ETFs built to invest in companies with left-handed Sagittarian CEOs, companies with cute corporate logos, companies in industries not yet discovered, and companies most likely to be acquired by extraterrestrials. Well, not yet. Wait a while. ETFs have been created for fanciful "indexes" that are neither asset classes, sectors, or investment styles. In other words, a mixed bag, just like mutual funds. Good and bad ETFs exist. ETFs are just not an asset class.

Are ETFs somehow a "threat" to open-end mutual funds and hedge funds? No more than open-end actively-managed mutual funds are a "threat" to investors! Yes, they are gaining market share, presumably at the expense of the worst of the active funds. If so, thank God. The article suggests that hedge fund replication ETfs are a threat to hedge funds. May it be so. One can hope. How much money do investors have to lose to learn that lesson? Opinion
ETFs, Indexation Threaten Mutual, Hedge Funds: Michael R. Sesit

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