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Just Released: August 2016 ETF Edge — Learn More

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The rapid expansion of the ETF industry has been one of the most important developments in the past few decades for financial professionals. Advisors now have more tools in their toolkits than ever before to help construct client portfolios.

With these new financial products comes the responsibility to understand the various risk factors and nuances associated with them. As the industry has expanded, the amount of information to digest has swelled as well. While ETF education must be an ongoing process, there are a number of basics that can enhance overall understanding, the identification of opportunities and limitations, and generally promote a better ETF experience.

1. Volume ≠ Liquidity

Frozen waterfall in winter

Many advisors and investors like to implement what can best be described as “liquidity screens", refusing to consider products that don’t have a certain average daily trading volume (25,000 shares daily is a common rule of thumb). That could be a big mistake, as this approach results in overlooking hundreds of smaller products that may offer compelling investment theses and unique exposure.

The historical volume of an ETF tells very little about how liquid it is because ETFs are capable of something called “spontaneous liquidity". Because there is a mechanism in place that allows for the creation of new shares almost immediately, it is possible to execute large trades in thinly-traded funds without moving the price by a meaningful amount [sign up for the free ETFdb newsletter].

It’s been noted that ETFs trade like stocks, which is part of the appeal of the exchange-traded structure. But there are limits to that comparison; savvy investors who know what they’re doing (more on this below), could potentially buy one million shares of an ETF that trades 10,000 shares daily within a few basis points of NAV. That might sound hard to believe, but it’s absolutely true, and part of the beauty of ETFs.

A quick call to any ETF issuer will get you speedy assistance on the execution side. Alternatively, there are firms such as Street One Financial and WallachBeth that can provide smooth execution of block trades for a minimal fee.

2. Market Orders Just Might Burn You

It should be noted, however, that achieving a desired level of liquidity in an ETF often requires a bit of work and diligence. Advisors accustomed to the execution of positions in mutual funds must be aware that ETFs work in an entirely different manner. Rather than being bought and sold directly from and to the fund company, ETFs are often sold between market participants. And there is no guarantee that trades will be executed at or near NAV; rather, shares change hands at whatever price clears the markets.

Low volume ETFs should not be avoided due to liquidity-related fears, however, low average daily trading volumes should result in additional caution being paid when buying or selling a fund for a client portfolio. Wide bid-ask spreads can result in additional fees incurred, putting clients in an early hole.

Fortunately, the tools for avoiding such pitfalls are both cheap and easy to use; limit orders can be tremendously powerful mechanisms for investors.

3. Not All ETF Expense Ratios Are Created Equal

coins laid out on a table

Advisors making the switch from mutual funds to ETFs have a tendency to pat themselves on the back for embracing low-cost strategies that will earn their clients money over the long run. The assumption that all ETFs are created equal, however, is utterly false. The reality is that the gaps between funds offering similar (or nearly identical) exposure can be drastically different.

The best example is a comparison of the three S&P 500 ETFs: the State Street SPDR S&P 500 (SPY A), the iShares Core S&P 500 ETF (IVV A), and Vanguard’s S&P 500 ETF (VOO A), all of which track the same underlying index. The expense ratios are 0.09%, 0.07%, and 0.05%, respectively. There are a number of other examples of similar products with huge gaps in expenses, and the impact over the long run can be significant.

For anyone serious about minimizing fees, it pays to shop around. Not all ETFs are created equal when it comes to cost efficiency.

4. Bigger Does Not Mean Better

When evaluating potential ETF options, there is a tendency among advisors to gravitate towards products that have the largest asset base and average daily volume, or to pick only those funds issued from well-known players such as iShares and Vanguard. Many of the largest exchange-traded products are popular for a reason: they offer cheap, efficient access to desirable asset classes. But in many instances, the size of an ETF is more indicative of the length of its operating history than the attractiveness of the underlying portfolio and methodology to long-term investors. Innovation in the ETF space has gradually refined the type of exposure offered, and many of the newer, smaller products solve some of the issues that plagued the first generation of ETFs.

The FTSE China 25 Index Fund (FXI A-) is a great example. That fund is by far the most popular China ETF on the market with almost $7 billion in assets (as of 5/5/15). But for investors seeking long-term exposure to the Chinese economy, it’s pretty safe to say that there are better choices available. FXI’s portfolio is both shallow (25 stocks in total) and extremely unbalanced; financials account for the majority of exposure, while consumer, tech, and health care stocks get little or no weighting.

Don’t assume that a hefty asset base is the only indication of the efficiency of an ETF. More often than not, digging beyond the most popular product in a category will uncover some hidden gems in the space [see Financials Free ETFdb Portfolio].

5. There’s More To ETF Expenses Than Expense Ratios

new york stock excahnge

It should also be noted that expense ratios do not tell the entire story when it comes to ETF expenses. There are other components that must be considered when determining the total cost of an ETF investment.

Commissions are one area in which a little effort can go a long way. In recent years, various brokerages have rolled out programs that include commission-free trading on popular funds in an effort to attract investors who value and use ETFs frequently. Paying $7.00 or $10.00 to execute a trade might not seem like much, and for larger portfolios with minimal turnover the impact of trading commissions may be minimal, but for smaller accounts, fees can add up quickly, potentially equaling the basis point contribution of expense ratios.

Bid-ask spreads should also be considered when evaluating an ETF. Buying at a premium or selling at a discount has the same impact on bottom-line returns as a higher expense ratio [see The Total Cost Of ETF Investing].

6. Structure Matters

The term “ETF” is often used incorrectly to refer to products that are not technically exchange-traded funds. More accurately, the “ETP” umbrella can be described as covering a number of exchange-traded products, including ETFs, ETNs (exchange-traded notes), UITs (unit investment trusts), grantor trusts, and others. From the perspective of most investors, these slightly different structures are generally similar; each offers transparent, liquid access to an underlying basket of securities.

In some instances, however, structure matters. ETFs and ETNs may be similar in many respects, but they are very different in others. And the differences are not limited to credit risk and tracking error. In certain asset classes, such as commodities or MLPs, the choice of structure can end up having a huge impact on tax consequences, and bottom-line returns and volatility. Using the head-to-head ETF comparison tool to analyze the ALPS Alerian MLP ETF (AMLP B+) and the UBS E-TRACS Alerian MLP Infrastructure Index (MLPI A) illustrates this point quite nicely. Though AMLP (an ETF) and MLPI (an ETN) are linked to the same index, their performances are not identical [see When ETNs Are Better Than ETFs].

There are a number of other examples of structure impacting the risk/return profile achieved by an exchange-traded product. The State Street SPDR S&P 500 (SPY A), a UIT, will perform differently than the iShares Core S&P 500 ETF (IVV A), which is also linked to the S&P 500 but structured as an ETF. The three ETPs that offer exposure to the USD/EUR exchange rate maintain unique tax consequences and counterparty risk, and annual performance can vary by more than 100 basis points depending on the environment.

7. Commodity ETFs Get A Bad Rap

gold bars in a stack

Commodity ETFs were repeatedly dragged through the mud from 2008 to 2011, primarily due to misunderstandings (or perhaps outright ignorance) regarding their true objectives and limitations. Specifically, the “tracking error” between the returns generated by commodity ETPs and the change in the spot price of the related resource seemed to cause problems. While it’s true that most commodity ETFs deliver returns that differ from a hypothetical return on spot prices, sometimes by a significant margin, that deviation isn’t the result of a flaw in these products. Rather, it reflects confusion over exactly what these products seek to achieve and the methods they use to go about it.

It’s important to exercise caution when investing in commodity ETPs. Advisors without a firm grasp on the nuances of a futures-based strategy have no business adding these products to clients’ portfolios. For those who do understand what’s under the hood of these funds and the potential limitations associated with the methodology used to achieve exposure, commodity ETFs can be very powerful tools that bring both return enhancement and diversification benefits to traditional stock-and-bond portfolios [see What BusinessWeek Didn’t Tell You About Commodity ETFs].

Commodity ETPs aren’t for everyone. But they certainly aren’t the flawed, return-eroding vehicles that some have made them out to be.

8. Diversification Should Not Be An Assumption

ETFs, like mutual funds before them, have become popular among investors with a long-term focus looking to achieve cheap and easy diversification. Many ETFs include hundreds or even thousands of individual securities, allowing for broad-based exposure that would otherwise be prohibitively expensive and time consuming to establish.

But not all ETFs offer tremendous diversification. Some, in fact, are quite concentrated in a small number of individual stocks or in a few select sectors. It isn’t all that uncommon for a product to allocate 20% or more to a single holding, or for a single sector (often financials) to make up 50% of a fund’s portfolio. Diversification across companies and sectors is generally the rule, but there are plenty of exceptions.

An oft-cited advantage of ETFs is transparency; investors can see exactly what a fund holds in close to real time. Take advantage of that feature and be sure to know what a product holds before establishing a position.

9. ETFs Can Close…

The ETF industry can be described as both extremely deep and extremely top-heavy. There are more than 1,600 products available, 25 of which account for nearly half of total assets. Close to half of the funds now trading have less than $25 million in AUM (a rule of thumb for the level of assets required to break even). The economics of an industry built around bargain-basement expense ratios can be challenging to issuers.

It costs money to run an ETF, and a significant portion of the products now available are losing money. Many of those cash drains are young products still establishing a track record and attracting assets. Some of them will grow into products with hundreds of millions in assets that generate profits for the issuers while still offering low expenses to investors.

But some will not, and they will ultimately be shut down. There are three certainties in life: death, taxes, and the fact that several ETFs will close down in coming years. It’s something advisors should acknowledge, though it need not scare anyone off. An ETF closing is no cause for panic. Investors will have the opportunity to either sell shares prior to the delisting or receive cash proceeds. However, it is less than optimal; the sale may trigger tax liabilities, and there are costs associated with redeploying capital.

Overall, an ETF closure isn’t really a big deal; an advisors clients will get their capital back, and the hunt for a suitable alternative will begin [see How To Deal With ETF Closures].

10. …And ETNs Can Fail

ETNs have become popular tools for accessing certain asset classes. This structure has several potential tax advantages when it comes to accessing commodities, MLPs, and other strategies. The ETN structure allows for the avoidance of tracking error, a deviation from the performance of an index that can erode returns, especially to futures-based strategies. But there are some risks to ETNs as well.

These securities are senior, unsecured debt instruments issued by financial institutions, and as such are subject to the same risk factors as more traditional forms of debt. If an ETF issuer goes out of business, investors in that company’s funds will have their capital returned. If an ETN issuer goes under, the consequences are much more severe; investors become creditors to the bank and will likely find themselves in line with other counterparties owed money by a bankrupt institution.

The risk of an ETN leaving investors holding the bag may seem pretty remote; the issuers of these notes are often large, well capitalized banks such as Credit Suisse, UBS, and Barclays. And even in a less-than-stellar economic environment, the possibility of one of these firms going belly up is minimal. At the same time, the collapse of an ETN issuer wouldn’t be without precedent; Lehman Brothers offered a lineup of exchange-traded notes prior to its sudden bankruptcy in 2008 [see ETF Hall Of Shame].

11. There’s An ETF For That

cows standing in a field

The first generation of exchange-traded products were generally “plain vanilla” funds linked to well-known stock and bond indexes such as the S&P 500 or Russell 2000. But over the late 2000s and early 2010s, an impressive string of innovation in the industry resulted in a product lineup full of specialized and targeted products. Just about every major global economy is now covered by an exchange-traded fund and in many cases there are multiple options available.

Targeted sector funds are becoming increasingly common; from the social media ETF to business development company ETNs to funds focused on the automotive industry, getting granular is not a problem [For updates on all new ETFs, sign up for the free ETFdb newsletter].

The ETF boom has democratized entire asset classes. The surge in usage of commodity ETFs and volatility ETPs is perhaps the best example of that phenomenon. Growth in the space has also opened up opportunities to achieve quick, easy exposure to an investment strategy. The investment discipline ETFs from Russell offer exposure to techniques such as aggressive growth, contrarian investing, and low P/E stock selection.

Whichever investment strategy or asset class one has in mind, chances are there’s an ETF for that. ETFs aren’t just for buy-and-holders seeking plain vanilla exposure; they offer the ability to become extremely specialized and fine tune the desired exposure.

12. Keep It Simple…

There are now more than 1,600 exchange-traded products available and the lineup is growing rapidly. While many of the most popular funds offer exposure to straightforward strategies covering key asset classes, there are hundreds of ETFs that utilize leverage, derivatives, and other sophisticated techniques to tap into sophisticated strategies. Many of the ETFs on the market have little or no use to the vast majority of investors. Those looking to build a balanced, long-term, buy-and-hold portfolio realistically only care about a small fraction of the ETF universe.

Think of the ETF universe as a toolkit, and individual ETFs as the tools. The more tools at one’s disposal, the better. But certain tools are useful for some tasks and wildly inappropriate for others. A chainsaw is useful if you’re looking to cut down a tree. But when you’re slicing a loaf of bread it can produce disastrous results.

The point is this: most ETFs out there are not useful for your clients’ objectives. And that’s just fine. Just because a product is out there doesn’t mean it needs to be included in a portfolio. Follow this simple advice when determining the suitability of a potential ETF investment: if you can’t understand the components, strategy, and risk factors in five minutes, walk away.

13. …But Not Too Simple

textbook with pens

One interesting development in the ETF industry includes target-date products designed to “glide” towards a retirement date in the future by gradually shifting towards bonds and away from stocks. For those looking to minimize complexity and maintenance requirements, targeted retirement-date ETFs are about as simple as it gets. Theoretically, a client could hold a single ticker that automatically adjusts allocations to key asset classes as they age.

Target-date ETFs might be useful for some but the limitations and potential drawbacks of these products are numerous. First, there is the obvious point that time to retirement is only one factor that shapes a client’s asset allocation process. Overall wealth, risk tolerance, and presence of income streams should also be considered.

Second, the allocations in some of these products seem to be disconnected from reality. Consider the Russell Equity ETF (ONEF B+), presumably designed for investors with a fairly long time until retirement. Emerging markets account for approximately 2% of total assets. Even acknowledging that U.S. investors tend to maintain a “home country bias” that results in underweighting emerging markets, that allocation seems woefully low.

Finally, there is the issue of expenses. Because these ETFs are structured as ETFs of ETFs, there are two layers of fees. In addition to the management fee on the fund (ONEF charges 0.51%), each of the component products incurs expenses that push up the effective cost to clients. For those in it for the long haul, the compounding of such costs can eat into returns.

Odds are, it’s best to stay away from target-retirement-date ETFs; take the time customize exposure to your clients’ portfolios and they’ll thank you later.

14. Watch Your Weight

When considering potential ETF investments for accessing domestic or international stock markets, most advisors probably give little or no thought to the weighting methodology employed by the underlying index. While that might seem like a minor impact that is unlikely to have much of an impact on returns, the reality is that the manner in which weightings are assigned to component stocks can translate into huge differentials in performance.

The majority of stock ETF assets are in products linked to market capitalization weighted indexes, based on a methodology that gives bigger weightings to more valuable companies. But as alternatives have become more readily available, the potential drawbacks of cap-weighting strategies have become more obvious. There are now ETFs that assign weights to component stocks based on various “fundamental” factors, including sales, earnings, dividend, cash flow, estimated earnings, and even book value.

The impact of this seemingly minor nuance can be significant. The performance of the Rydex S&P Equal Weight ETF (RSP B+) and S&P 500 SPDR (SPY A) in 2010 highlights this point nicely. The components of these two stocks are identical; both hold the 500 or so equities that make up the S&P 500. But RSP, which gives an equal weight to each, outperformed SPY in 2010 by about 600 basis points. For two products that have identical portfolios, that’s a pretty significant gap [see RSP Just Keeps Chugging Along].

If you’ve historically relied on cap-weighted products, there’s a lot to learn about the alternatives. But it’s a lesson well worth the effort; the result could be a relatively easy way to improve your clients’ bottom line returns.

15. Contango Can Be A Killer (And Backwardation Can Be A Blessing)

field of wheat stalks

A recurring theme here has been the importance of looking under the hood and knowing exactly what you are buying for your clients. This is particularly true in the commodity ETF space, a corner of the market that has exploded in recent years. Investors have embraced the exchange-traded structure as a way to tap into an asset class with tremendous return enhancement and diversification potential.

It is important to understand that the vast majority of exchange-traded commodity products do not seek to deliver returns that correspond to movements in the price of the spot commodity. In most cases, that simply is not possible; the logistics of owning livestock or natural gas, for example, are obviously challenging. Rather, these funds offer access to a futures-based strategy that invests in securities linked to underlying commodities. While the correlation is strong, the performances are in no way identical; often, the gap between a futures-based product and the hypothetical return on spot is significant.

Commodity ETFs can be very powerful tools but it’s important to recognize their limitations. If you’re expecting access to spot natural resources, you haven’t done your homework, and could be setting clients up for a big disappointment [see How Contango Impacts ETFs].

16. There’s More To ETFs Than Low Fees

When asked to explain the undeniable shift in the investing landscape from mutual funds to ETFs, most investors, journalists, and analysts will jump to one issue: expenses–or the lack thereof. The average expense ratio in the ETF universe comes in at about 59 basis points while the weighted average is considerably lower (in the neighborhood of 0.33%). Some ETFs charge as little as five basis points, a fraction of the 1.4% or so that is the average among mutual funds.

It’s easy to see why expenses stand out as the primary driver of the river of cash flowing from mutual funds to ETFs. However, it’s worth noting that lower expenses are just one of the advantages an exchange-traded structure can bring to client portfolios. Relative to their mutual fund counterparts, exchange-traded products have a number of other advantages:

  • Liquidity: ETFs can be traded like stocks throughout the course of the day. That flexibility can come in handy when advisors are looking to be nimble and move a client quickly into or out of a position. Rather than having to wait until the end of the day, ETFs allow advisors to execute trades in a matter of seconds–a period of time that can translate into significant dollars in some cases.
  • Transparency: The transparency of ETFs allows advisors to know what they hold in close to real time, instead of waiting for quarterly disclosure statements to see how significant their client’s exposure to a particular security is. When stocks are tanking, it can help to know exactly what you hold–as anyone who has been forced to speculate on the degree of exposure to BAC or NFLX can attest.
  • Tax Efficiency: The nuances of the creation/redemption mechanism generally result in superior tax efficiencies for ETFs, essentially allowing investors to control the timing of their obligations. For those who have become accustomed to being impacted by the redemptions of other fund investors, this efficiency might be a welcome change.

The low-cost feature is just the tip of the iceberg; there are plenty of other reasons to make the switch from mutual funds to ETFs.

17. ETFs Are Not An Acceptance Of Mediocrity

Wall street corner sign

Some skeptics view ETFs as an acceptance of mediocrity, tools for running with the pack and giving up on any chance of generating alpha through stock picking or other active techniques. That argument falls apart under even the most cursory of examinations. First, there exists a boatload of academic evidence suggesting that active managers, on the whole, fail to beat their benchmarks after fees are considered. Sure, there are some superstars who top their index year in and year out. But unless you’ve found the next Peter Lynch, an attempt to generate alpha is more likely to destroy value than to create it.

Regardless of where you stand on the value of active management, it should be abundantly clear that “beta instruments” such as ETFs can most certainly be used in the pursuit of alpha. Again, research suggests that asset allocation is responsible for a significant portion of portfolio returns. ETFs are the perfect tool for tilting exposure towards certain assets and away from others without diving into the weeds and racking up the fees to choose between various stocks.

For advisors looking to actively manage a client portfolio, there’s no reason that ETFs can’t be an integral, cost-efficient part of that strategy.

18. ETFs Did Not Cause The Flash Crash

Another myth about ETFs is that these securities were the primary culprits behind the “Flash Crash", a chaotic day of trading in 2010 that saw several securities, including a number of ETFs, lose and then recover billions of dollars in a matter of seconds. Since a disproportionate number of the securities impacted on that day were ETFs, rumors began to spread that these vehicles were somehow responsible. In reality, ETFs were simply swept up in the chaos, impacted heavily because of the breakdown in the creation/redemption mechanism that generally keeps prices and NAV closely aligned.

The details behind that day and the role that ETFs played in the chaos is enough to fill a novel. For those who want to dig a bit deeper into the weeds, there is plenty of well-reasoned analysis on exactly what happened that day and the role ETFs played.

19. An ETF Cannot Collapse

building collapse

To continue the myth-busting portion of this article, let’s move on to another misconception that gained momentum early in 2011. That year, several research papers were published that purportedly detailed how certain exchange-traded products could collapse, leaving investors without the exposure they thought they had established.

The notion that ETFs with significant short positions could potentially collapse centered on the idea that a wave of redemptions would eliminate all outstanding shares of the fund. However, the reasoning behind this notion, which was picked up by several mainstream media outlets, presumably for “shock” value, was flawed from the beginning.

The reason an ETF cannot collapse is quite straightforward; redemptions require settled shares of an ETF, meaning that access to and control of the shares in question must be shown before a redemption can take place. The mechanics become complex here, so rather than delve into an extended analysis, we’ll provide a few links that contain in-depth explanations and analysis on why ETFs, even those with huge net short positions, are in no danger of collapsing.

20. Bond ETFs Can Be Flawed

As of the late 2000s and early 2010s, more and more advisors have embraced exchange-traded funds as tools for establishing fixed-income exposure, accessing bonds through a structure that provides lower costs and enhanced transparency. While the marriage of fixed income and the exchange-traded structure has tremendous potential, there are a number of noteworthy factors that should be considered before going down this road.

First, the cash flow experience of bond ETFs differs from holding an actual bond. The majority of bond ETFs, including popular funds such as iShares’ Core Total U.S. Bond Market ETF (AGG A+) and Vanguard’s Total Bond Market ETF (BND A), are designed to operate indefinitely. That means that proceeds from any bonds reaching maturity are reinvested into new securities. In most cases, the effective maturities of bond ETFs remains constant over time, meaning that interest rate risk will not decline as clients age. This isn’t the end of the world for advisors, but it does mean that more diligent monitoring may be required with these products [see Are Bond ETFs Broken?].

There are also a number of “target-date” bond ETFs designed to more closely replicate the experience of holding actual bonds. These ETFs, including the BulletShares products from Guggenheim, focus on debt issues maturing in a specific year. As the maturity dates approach, the ETF’s portfolio shifts to cash, ultimately making a distribution to investors that represents the return of principal.

There are some additional factors that should be noted with respect to a few popular bond ETFs. Some investors see products such as AGG and BND as one-stop shops for fixed-income exposure. But even though these funds are in our Total Bond Market ETFdb Category, there are some noteworthy omissions from the portfolio [see our Better-Than-AGG Total Bond Market ETFdb Portfolio]. AGG and BND are tilted heavily towards U.S. Treasuries, holding nothing in the way of international bonds or junk bonds. While these ETFs can be valuable core holdings in a fixed-income portfolio, there is much more to complete bond market exposure that isn’t found in these funds [see Don’t Put All Your AGGs In One Basket].

21. ETFs Are A Vehicle (Not A Strategy)

pink vespa scooter

ETFs are generally associated with passive management and held out as alternatives to actively-managed mutual funds. It’s common to hear investors compare ETFs to active management, or mutual funds to indexing strategies. But it’s important to keep in mind that ETFs are a vehicle that can be used to achieve exposure to passive index replication or active management, just as mutual funds can also tap into either strategy.

22. Odds Are, You’ve Got Options

Once upon a time, accessing a strategy or asset class through exchange-traded products was a binary decision: you either did it, or you didn’t. And while the surge in ETPs in recent years has primarily been the result of innovation, there’s also been a fair amount of duplication. The result: many asset classes, and even indexes, are now covered by multiple exchange-traded products.

In other words, advisors likely have options among the ETF universe. It would be wise to take advantage of the abundance of choice; combing through the various options targeting a specific sector or benchmark can lower fees, improve the depth and balance of a portfolio, and optimize tax efficiency [see ETF Webinar: How To Find The Right ETF].

23. Nice Returns Can Come In Small Caps (Or Not)

newborn kitten sleeping

ETFs have become popular tools for establishing exposure to international stock markets ranging from developed markets in Western Europe, to emerging economies in Asia, to frontier markets in Africa, and beyond. Thanks to impressive innovation, just about every major global economy is accessible through a pure-play ETF.

At the same time, it is important to understand that most international stock ETFs, especially those that were launched in the early 2000s, are linked to cap-weighted indexes that tend to be dominated by the largest and most valuable companies in that market. This isn’t necessarily a bad thing, but the tilt towards large caps can have a meaningful impact on the returns achieved.

Specifically, large cap-heavy ETFs are likely to include companies that may generate revenue around the world though headquartered in a single market. As an example, imagine Coca-Cola: a U.S.-listed company that derives the bulk of its revenues from overseas operations. While technically a U.S. stock, the company is perhaps more dependent on consumption patterns in China and India.

Small cap ETFs have become popular tools because they can represent more of a “pure play” on the local economy–a chance to get closer to the ground in international markets and invest in companies that stand to benefit from growth in the local market. In many cases, these funds can exhibit returns that differ dramatically from their large-cap counterparts. As an illustration, consider the performance of two Brazil ETFs in 2012: the large cap-heavy EWZ and small cap-focused BRF.

TickerETF2014 Gain/Loss
(BRF A-)Brazil Small Cap ETF-25.79%
(EWZ B+)MSCI Brazil Index Fund-15.52%

Both are Brazil ETFs, but the two products are far from identical.

There are a number of small-cap ETFs out there that offer international equity exposure, and in many cases these products may be a better fit for clients’ portfolios than their large-cap counterparts.

24. Sometimes, ETFs Aren’t The Best Option

Don’t get us wrong; the team at ETFdb includes some of the biggest ETF fans in the world. The tremendous growth of the industry in the late 2000s and early 2010s is a testament to the advantages inherent in the exchange-traded structure These include lower costs, excellent transparency, intraday liquidity, and improved tax efficiencies. In many cases, the exchange-traded structure is simply a better mousetrap; it represents the optimal vehicle for accessing a wide variety of asset classes. At the same time, there are some cases in which it might make sense to employ another strategy. ETFs are not always the most appropriate tool in the toolbox.

Though ETFs are generally cheaper than their mutual fund counterparts, that isn’t always the case. Some Vanguard mutual funds, for example, offer a total cost proposition, including management fees, transaction fees, and bid-ask spread considerations, that ETFs can’t top.

Moreover, there may be some asset classes for which investors are more comfortable with the expertise of an experienced management team, as opposed to subscribing to an indexing strategy that simply seeks to replicate a rules-based benchmark. Emerging market debt, for example, is one corner of the market in which knowledge of liquidity issues, and the nuances of individual issues, can come in handy, allowing an active manager the opportunity to add value.

25. Free ETF Tools Can Make Your Life Easier

Country exposure tool

As of 2014, the ETP universe now stands at more than 1,600 available products and is rapidly expanding. With a growing number of increasingly complex tools available to more and more investors, keeping track of all the choices and identifying the best product for your investment objectives is no easy task. To this end, there are a number of free analytical resources out there designed specifically for financial advisors who use exchange-traded funds. Below, we list some of the free tools available at ETFdb.com:

These tools help build a roadmap to successful investing strategies, allowing advisors to dissect the ETF universe in countless ways, easily comparing products to find the funds that are best for their clients.

The Bottom Line

The most powerful weapon an investor has is education. Always ensure that you fully understand and have researched any security prior to making an investment.

Disclosure: No positions at time of writing.

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