Exchange traded funds are both a blessing and the curse for individual investors these days. On the plus side, good ETFs allow folks easy access to sector bets and diverse investments with low fees and ease of trading. On the down side, everybody and their cousin is getting into the ETF game and creating an increasingly muddled marketplace makes selecting the best fund difficult.
Specifically, there are over 1,000 ETFs to choose from, with more than 230 new ETFs launched in the last year alone – and over 700 more in the pipeline if you believe a report from IndexUniverse.
So how do we fix this mess? Simple: The ETF marketplace should focus on quality and not quantity.
That’s in the best interests of fund managers as well as investors. For instance, a top strategist at ConvergEx group told the Financial Times just 17 of the funds debuting last year attracted enough investors to generate “worthwhile profits”– that is, more than $100,000. And according to Business Insider, at the end of November, more than 350 ETFs held under $25 million in assets “a rule-of-thumb break even point for ETF issuers.” The market clearly can’t support a universe of ETFs this size.
So allow me to offer my suggestions for the first 3 funds that should be first in line on the chopping block:
Direxion Airline Shares ETF (FLYX)
Leveraged ETFs – that is, funds that are meant to provide two times or three times a benchmark – are the bread and butter of Direxion. But the fund manager dipped its toes into the conventional ETF game space with the lift-off of the Direxion Airline Shares ETF (NYSE: FLYX). Why? First off, we already enjoy the meager Guggenheim Airline ETF (NYSE: FAA) – which had less than $40 million in assets as FLXY took off.
What’s more, it’s not like airlines are a dynamic group of stocks with a lot of new companies or a wide variety of strategies or a big universe of stocks. The icing on the cake is that BOTH of these are simply benchmarked to the NYSE Arca Airline Index and don’t have a creative bent of their own.
One has to go – and since FLYX debuted just three months ago, I nominate this Direxion ETF to get the axe.
B2B Internet HOLDRS (BHH)
Ok, put your thinking caps on — because the B2B Internet HOLDRS (NYSE: BHH) is not an easy product to explain. In fact, the complexity is a top reason to kill it.
But let me do the best I can in a few sentences: First off, BHH is not technically an ETF — it charges a flat fee for every lot of 100 HOLDR Units, and that fee is deducted from distributions. HOLDRS treat acquisitions of underlying companies differently than most ETFs. Secondly, acquisitions are treated in a drastically different manner — if a component stock is bought out, investors in BHH are treated as normal shareholders and given a cash distribution in proportion to their HOLDR units. That’s why on paper the fund has lost 98% since inception and has a mere two components — it has “sold off” its assets.
As you can see, this is a very strange arrangement. And while innovations on Wall Street should be encouraged, your typical retail investor has an awful hard time wrapping their head around something like this.
Though I guess I shouldn’t make too much of a fuss – all we have to wait for holdings Ariba Inc. (NASDAQ: ARBA) and Internet Capital Group (NASDAQ: ICGE) to get bought out, and this fund will have no other component companies and thus no value.
WisdomTree Middle East Dividend Fund (GULF)
The specific example of the WisdomTree Middle East Dividend Fund (NYSE: GULF) is part of a general trend among ETFs to blend strategies in a way that just seems strange. So let’s say you’re thinking of investing in the Middle East — a complicated task considering there is a dearth of publicly traded companies in the region, and the few that are there are largely outside the U.S. stock exchange.
Well, that’s what many emerging market ETFs have been made for, right? To bring out-of-reach investments in Brazil and Taiwan to everyday armchair investors. But what in the world made someone at Wisdom Tree decide to work in a dividend flavor on top of this? The result is a strange fund made up of telecoms and banks in the area – with the top holding being Kuwait’s Mobile Telecommunications Company (Zain), at 15% of the portfolio.
I don’t mind logical mixing of strategies — like that Goober Grape spread from Smuckers that puts peanut butter and jelly mixed together in the same jar. But this is like a jar that contains pureed bread, lettuce, turkey, cheese and mayo. Some things are best bought separately and assembled by the consumer.
iShares NYSE Composite Index Fund (NY)
Ah, index funds. These ETFs are the shining stars of the universe, truly upgrading the mutual fund model for the 21st century. The landmark SPDR S&P 500 ETF (NYSE: SPY) has a whopping $97.7B in assets and trades over 150 million shares on a given day, and is a valuable tool for both buy-and-hold investors, short-term traders and even the options crowd. There are a host of other S&P 500 index funds too, and though this is the largest there are plenty of other successful ETFs with the same flavor – providing more options and competition for lower fees, both of which are good for investors.
Unfortunately, just because the S&P 500 index fund is a good idea that doesn’t mean all index funds are. Take the iShares NYSE 100 Index Fund (NYSE: NY), benchmarked to the NYSE U.S. 100 Index. It garners under $75 million in assets and trades a pathetic 3,000 shares a day.
The reasons should be obvious, since the NYSE 100 has little popularity among investors or the media. So why benchmark a fund to it — or to the IPOX-100 or the S&P/TOPIX 150 or any other arcane grouping of stocks. Either actively manage your ETF holdings, or pick a benchmark investors can understand.
The miniscule assets and volume of the NY fund proves that there’s no benefit in backing an obscure index nobody has heard of with its own ETF.
The iShares S&P Global Nuclear Energy Index Fund (NUCL)
A different side of the same index coin is the iShares S&P Global Nuclear Energy Index Fund (NYSE: NUCL). Just because there’s a Global Nuclear Energy Index doesn’t mean we need an ETF benchmarked to it.
Or put another way, if you are going to get so specific about what you want to focus your investment on – in this case, nuclear energy – why would you need the diversification of an ETF or suffer the 0.48% expense ratio? What’s more, uranium miner Cameco (NYSE: CCJ), Mitsubishi Electric (PINK: MIELY) and London engineering firm Amec plc (PINK: AMCBY) account for nearly 27% of the fund. Why not just buy these three stocks on your own?
With total assets of under $28 million, it’s clear that many investors have asked themselves these same questions and come to the same conclusion. In short, that the NUCL nuclear fund is difficult to fit into most portfolios.
Jeff Reeves is editor of InvestorPlace.com. As of this writing, he did not own a position in any of the stocks named here. Follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook.
