Aug 6, 2007

ETF Investor, Why are ETFs so sexy?

Think of a way to group a bunch of stocks and there is already an ETF for that. Yeah, ETFs are a cliche these days. For people like me, ETFs have been a big boon because ETFs brings the best of both worlds, from the world of Mutual Funds and Stocks. ETF investments are a craze now.

Advantages of ETFs over Mutual Funds is a well addressed topic and a good example of this is seen in this article on Seekingalpha.com . Read this article if you want to brushup on the benefits of ETFs. But investing in ETFs is beneficial in many other ways too, and I want to talk about these other benefits that are not discussed much. Here is a primer on ETFs if you want to know the basics.

But bear in mind that ETFs are still new and they are yet to be tested for its suitability for long term investments. So exercise your judgement before you use ETFs in your long term investments.

I have found ETFs to be significantly advantageous in many ways. Thanks to the companies (I think that was Spyders who brought SPY first) that came up with the concept of Exchange Traded Funds (ETF).

  1. The first one is being able to purchase a specific narrow industry niche. ETF industry is growing so fast and the market place is filled with ETFs for each market segment possible, whether it is by geography or by industry sector or by strategies or by indixes or by Inverse stratigies. This has enabled investors to find an ETF for any narrow niche. Examples would be: ETF for stocks from China & India combined (FNI), ETF for growing twice the rate of S&P500 (SEV), etc. With ETFs you are able to get the precise exposure to a segment that you want rather than buying a fund with all the unwanted stocks along with the ones you want. More on ETF trends here.
  2. Some of the strategy driven ETFs are very interesting, like sector rotation XRO. This ETF purchases cyclical sectors prior to their anticipated period of expansion and similarly sell them before the anticipated contraction. I am not recommending to buy this ETF, rather I am highlighting the fact that this kind of opportunity to rotate sectors did not exist before for individual traders, unless you wanted to deal with stocks directly. ETFs have opened up opportunities for individual investors to select a strategy that suits their situation. Say if you want twice the returns of an S&P 500, go for Proshares SEV ETF or go for Short S&P500 (SH) from Proshares. These choices have newly become easily available to individuals now.
  3. Many of the ETFs are Optionable. What does that mean? It means tonnes of opportunities like: leveraging investments with CALLS and PUTS, getting downside protection with PUT calls, earning constant revenue via covered calls & spreads, and you can even short the ETFs. You can use ETF options just like you would do with stocks. Options take investing to a whole new level, and if you are good at it you can not only protect your investment, but you can grow it very well too.
  4. ETFs trade during the entire day just like stocks do. That means all the technical indicators involving price and volume actions will hold good too. Techical indicators like MACD, RSI, OBV, Accumulation/Distribution, etc all hold good and can be used to time the purchase/sale of the security. This is as opposed to the Mutual Funds that are traded at the end of the day using the NAV (Net Asset Value) for the day.
  5. Many times if your favorite ETF is out of favor in the market, then the ETF might be available for a discount to its NAV value. So if you time your ETF purchase right you might be able to get a bargain price for the stocks that are in the ETF. You can see this on a website like Morningstar.com or etfconnect.com

All these factors have made ETFs one of my favorite vehicles of investing. I am cautious in selecting my ETFs since many of these are new and are never tested. And not all the ETFs may succeed in delivering what they are set out to do. I suggest that you be prudent in your ETF selections and have fun making profits.

-Nidhi

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