ETFs 101

07/18/2003 12:00 am EST


Exchange Traded Funds (ETFs) continue to gain in popularity and numerous readers have asked for a more in-depth explanation of ETFs and how they can be incorporated into their investment strategy. Here, a number of top advisors--including Joe Battipaglia, Jim Lowell, and Doug Fabian --explain the basics of ETFs. (For more information on any of these advisors, please click on their photos below.)

Battipaglia, JoeWhat is an exchange traded fund? Joe Battipaglia, chief investment officer at Ryan, Beck & Co., notes, "An ETF is a basket of securities that can be bought and sold on an exchange just like an individual stock. Most ETF portfolios track a specific market index which may be tied to dozens or hundreds of other securities. Some ETFs track the performance of equities including large-, mid-, and small-capitalization US equities, foreign equities, and style indices (growth or value). Others track the performance of fixed income investments. These include Treasuries, corporate bonds, and real estate investment trust ETFs. Other ETFs track industry-specific, global, and country specific indices. The ETF marketplace has developed rapidly since the first ETF was introduced in 1993. Since then, the market has grown into 116 funds with over $100 billion in assets. We believe that the market for ETFs will continue to develop over time and further broaden the range of choices available to investors.

Here, Battipaglia explains how ETFs can be used to create a diversified portfolio based on asset allocation. He explains, "Asset class performance can change over time; their returns can deviate significantly from their long-run averages over shorter time periods thus making strategic asset allocation decisions a viable option for portfolio management, especially when used in conjunction with ETFs. A simple portfolio strategy can be implemented using exchange traded funds: SPDRs can be used for large caps, as they track the S&P 500 Depository Shares (SPY ASE). The iShares Mid-Cap 600 Index (IJT ASE) can be used for small caps. iShares Goldman Sachs Corporate Bond (LQD ASE) can be used for high grade corporate. The iShares MSCI EAFI (EFA ASE) track the Morgan Stanley EAFE index and can be used for foreign stocks. In addition, the iShares Dow Jones US Real Estate (IYR ASE) offers real estate exposure."

Lowell, Jim"Fidelity has filed to offer its first exchange-traded fund (ETF), in effect validating the ETF vehicle as not only viable but marketable; I'm always interested in the timing of new investment products from Fidelity, since it suggests that Fidelity thinks there is a market for the product, notes Jim Lowell, editor of The Fidelity Investor. "ETFs trade like stocks, throughout the day instead of just at 4:00 pm Eastern Time prices (or hourly for Selects), incur the same commissions as stock trades, and you must have a brokerage account to buy them. But they tend to be index 'funds' with rock-bottom expense ratios (in this case, capped at 0.30% at least until 2006). Fidelity NASDAQ Composite Index Tracking Stock will seek to provide returns closely matching those of the NASDAQ Composite Index, an index of about 3,600 stocks traded on the NASDAQ (over-the-counter) market. The fund could be out as soon as Aug. 11. I might own it outright or in conjunction with OTC fund. We'll wait and see."

Fabian, Doug"If there's one thing that the recent $1.4 billion dollar Wall Street settlement tells us, it's the fact that there's too much hype behind individual stocks," notes Doug Fabian, editor of Successful Investing . "But there's an easier, more successful way to achieve gains for your portfolio. And you can do it without suffering the fate of an Enron, Worldcom, or K-Mart. The answer is exchange traded funds--di versified baskets of stocks that help you profit on the upside while significantly reducing downside risk. You can participate in the growth of a fast-moving segment of the economy, without the fear of one sour grape spoiling your wine."

We would note that there are a wide variety of ETFs that can suit almost any investment or trading purpose. Investors can use ETFs to gain broad diversification through a single vehicle. ETFs cover the gamut from a single country to a global portfolio; from a particular industry sector to a broad market index; from stocks to bonds. And the more liquid of the ETFs are highly suitable for traders, as these funds can generally be bought long or sold short, are not generally subject to the "uptick rule" and can be bought and sold throughout the day.

Finally, we would caution investors not to get confused by all the acronyms. Among the various exchange-traded funds are SPDRS, iShares, HOLDRs, VIPERs, etc. The main distinction is simply due to which firm has issued the ETF (Barclays Global, State Street, and Merrill Lynch are the dominant players behind these funds). Personally, we are excited to see the expansion of the ETF marketplace due to their low cost structure and the convenience they offer. Here at The Money Show Digest we will continue to bring you not only the best available advice on stocks, but also on the favorite ETFs from the financial advisory community.

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