Welcome to the investing mainstream, ETFs. You've got buzz, you've got momentum and now you've got issues.
Exchange-traded funds are the smaller but faster-growing rival to mutual funds. This week, they received a unique endorsement when one of the country's biggest fund companies, Invesco Trimark, introduced a lineup of eight funds that are basically a vehicle that investment advisers can use to put ETFs in client portfolios (read more here: tgam.ca/DnR).
Whether you're a do-it-yourself investor or have an adviser, ETFs are a versatile, sensible tool for portfolio building. But complaints about them are mounting, even as the global ETF industry prepares to supplement the existing 1,820 or so existing funds with another 811 new products. In this edition of the Portfolio Strategy column, we look at the dark side of ETFs by discussing four cases where buyers should beware.
1.) ETFs that track the price of a single commodity
These ETFs invest in futures contracts, which are essentially bets on what the price of a commodity like oil or natural gas will be at a future date. The problem is that futures contracts sometimes do a poor job of tracking the spot price of a commodity, which is the price in the here and now and the one most people pay attention to.
The issues associated with futures contracts have been exacerbated by huge investor demand for single-commodity ETFs. A good example is the United States Natural Gas Fund, which grew to $4-billion (U.S.) at midyear from $300-billion last December. This ETF was such a dominant player in the natural gas futures markets that regulators temporarily blocked it from issuing new units to satisfy investor demand.
“Generally people buy a fund called United States Natural Gas because they think they're tracking natural gas prices,” said Paul Justice, ETF strategist at Morningstar Inc. in Chicago. “They are not. They're using futures contrasts, which are generally – but not always – a good proxy for what gas prices are doing.”
