Q&A With Mark Kennedy of ETF.About.com

by on April 22, 2009

Mark Kennedy has traded ETFs for over 14 years. He was an ETF options trader on the Philadelphia Stock Exchange floor and a Vice President of Derivatives Trading for Goldman Sachs. Now he enjoys writing about ETFs and giving first-hand insight to his readers at About.com’s Exchange Traded Fund Web site. Mr. Kennedy was gracious enough to discuss the ETF industry, investing and more in an exclusive e-mail interview with ETF Database.

ETF Database: According to your online biography, you’ve spent “quite a few years screaming and yelling on the Philadelphia Stock Exchange (PHLX) floor”. How does the excitement of writing and maintaining an informational ETF Web site compare with trading on the floor?

Mr. Kennedy: “Screaming and yelling” on the floor is one of the greatest jobs ever. For me, there’s almost no comparison. However, it is a lot of fun to write about it as well. My experience lets me give readers some real insight into the world of ETFs. I try to include a lot of real life examples in my articles so potential investors can see how ETFs can be utilized. I don’t think I would be able to do that if not for actually being in the OIH (Oil ETF) pit.

ETF Database: There’s been a huge number of ETF issuances in the past two years, with many more on the horizon. Do you think this is a good thing for ETF investors? Will there be any unintended consequences from the issuance of so many ETFs in such a short period of time?

Mr. Kennedy: As far as volume, it’s a great thing. One of the drawbacks of ETFs is that some don’t garner any trading interest. I wrote a blog post earlier in the year about some ETFs that were shut down in 2008. The main reason, lack of interest. As more and more investors learn about the benefits of ETFs and as more and more investment companies create new ETFs, the hope is that trading volume increases. For any investment, that’s most of the battle. The unintended consequence is flooding the ETF market. At some point there is saturation. How many agricultural ETFs can exist before there are too many? A few will evolve and rise to the top, but the others will eventually shut down due to… again… a lack of interest.

ETF Database: What’s the most common mistake you see in ETF investing, among people new to ETFs?

Mr. Kennedy: The same mistakes I made when I first entered the oil pit. What the heck is an ETF?! Before you even think about trading one, you have to completely understand it. Not just knowing what it does, but what makes it run. Look under the hood. Does it consist of equities, futures, forwards, cash deposits, etc? What is an ETN as opposed to an ETF? As with any investment, you need to understand it before you buy or sell it or you’ll never get it to work.

ETF Database: A recent study by Barclays argues that leveraged ETFs are creating systemic risk in the markets. Do you agree with their argument?

Mr. Kennedy: Theoretically as the number of ETFs increase, this could happen. For a floor trader, the worst and best orders were the ones that came in right before the closing bell. The reason I say they were “good” and “bad” orders is because large, late trades are tough to hedge. You run out of time and not many investors are willing to take the other side of a late trade. So if you were one of the brave few, you were either going to do really well on the next opening or… not so well. Plus, you’d be watching the financial news all night. News is a dangerous thing to unhedged trades. On top of that, large, late trades also play havoc with marks. P&L reports are skewed. Closing bell prices aren’t accurate. Large trades would go up after hours, which would affect the next day’s opening… These types of trades complicated things. All that being said, these trades aren’t frequent. So for now I wouldn’t say it’s a huge problem… if not an opportunity. However, if the amount of leveraged ETFs were to increase, then yes, this could affect the volatility of the market and create more systematic risk. But if I recall correctly, I think there was a report from State Street Global Advisors of Boston that said the amount of ETF assets was down roughly 12% in 2008. Most of that is due to the current economic climate, but we’ll have to wait and see how it plays out.

ETF Database: Any words of wisdom–perhaps an unconventional investing tip–you could share with our readers?

Mr. Kennedy: If you have a lot of mutual funds in your portfolio, you may want to look into ETFs as well. Not only to reap the benefits of ETFs (like the tax advantages) but also help you reduce costs, commissions and fees. Worth a look. Also, as an oil index and oil ETF options trader, I found that ETFs could serve as a hedge for index derivatives if needed. Nailing down an index basket price is no easy feat, however an oil ETF can serve as a correlating hedge if it tracks the underlying index for your derivatives. It’s not the perfect hedge, but it can be close enough if you apply the right proportions.