Popular Move Into Battered Financials Doesn't Pan Out

June 10, 2008

Many investors - both great and small - have bought bank and other financial stocks over the last year. Rationales for these purchases probably included "the worst was over" or "the stocks were cheap and more than reflected the problems in lending." Early this year in we noted that there was more money going into the popular Financial Select Sector SPDR (XLF) after it fell sharply - a rare flip-flop in normal fund investor buy-high/sell-low behavior.

How have investors done since moving into financial stocks? Not so well. Yesterday Financial Select Sector SPDR (XLF) was near the 52-week low, down about 15% from early February.

Barron's discusses the bargain hunt that hasn't led to many bargains so far:

After riding out the credit crunch, the subprime-mortgage debacle and the March collapse of Bear Stearns, investors in April and May began bargain-hunting in the group. But June struck like a thunderbolt, with Lehman Brothers (ticker: LEH), the new hedge-fund whipping boy, plagued by rampant rumors about its liquidity. There were reports Lehman planned in response to push up its earnings release and announce a rights offering to raise capital."

As far as we're concerned, we're largely staying away from financials until something REALLY dramatic happens and scares away fund investors - a big commercial bank failure, a Fannie / Freddie catastrophe - before we'll consider a broad recommendation to bottom fish financial sector funds. As we noted in February, it's not a true buying opportunity until only a few people want to buy.

Vanguard Splits ETFs For Mysterious Reasons

June 4, 2008

Vanguard Splits ETFs For Mysterious Reasons

Apparently Vanguard has been a little too successful in attracting smart, fee-conscious, long-term investors.

Its relatively new exchange-traded (ETF) fund lineup has achieved remarkable success, hitting $50 billion in assets - $8.5 billion came in so far in 2008 alone. So why is Vanguard messing with such a good thing, using gimmicks the firm wouldn't use with its traditional funds?

This article off the Dow Jones Newswire offers possible explanations including:

The effect of Vanguard's share split will be to allow investors to trade the funds in smaller amounts. For now, each of the three ETFs' share price is more than $100. Shares of Vanguard Total Stock Market ETF are about $138, meaning that's the de facto minimum investment for any investor who wants to buy the fund, and the smallest increment in which existing investors can buy and sell. After the split the new number will should closer to $69."

But investors with less than $100 should probably not be investing in ETFs at all. Even at a cheap discount broker an ETF investor is going to pay $7 in commissions - which is a big chunk of a sub-$100 ETF investment. That kind of cost runs counter to one of exchange traded funds' main selling points - their cheapness of ownership. the rest of this article»

Sarcastically-Toned New ETF Launch Review

April 18, 2008

The great new ETF (exchange traded fund) stamped continues unabated. Who'd have thought there was so many wonderful investment opportunities that hadheretofore been ignored? This past week alone we've seen:

Claymore launch the Claymore/MAC Global Solar Energy Index ETF (Ticker 'TAN' - ha ha ha), which owns around 25 solar related stocks. Because frankly investing in the dozen or so existing alternative energy funds is just too darn diversified. This fund offers a hedge against Birkenstock-wearing 'no nukes' politicians screwing up your investment in the recently launched PowerShares Nuclear ETF (PKN) or Market Vectors Nuclear Energy ETF (NLR). Alternatively consider the ELEMENTS Credit Suisse Global Warming Index ETN (GWO) as a hedge against do-gooders.

Northern Trust launch the NETS™ TOPIX ETF (TYI) based on the Topix Japanese stock index, in addition to a smattering of other country funds. Hey at least they got the nerve to launch an ETF for the down and out Japanese market, most ETFs chase trends.

The debut of DB Agriculture Double Short ETN (AGA), DB Agriculture Double Long ETN (DAG), DB Agriculture Short ETN (ADZ), DB Agriculture Long ETN (AGF). Nothin says laissez-faire capitalist like four new ways to gamble on agriculture while residents of other countries riot over food shortages.

Yep, what a week. There hasn't been this many ETFs launched since...well since the week before last.

New Vanguard Global Index Fund - It's About Time

April 2, 2008

Everybody loves indexing, and indexing pioneer Vanguard certainly doesn't shut their yap about the benefits of indexing, but for some strange reason Vanguard has yet to deliver a global stock index fund. Vanguard offers dozens of index funds - now in ETF format as well as traditional open-end funds - to cover U.S. stocks and foreign markets, but they don't have a one stop product that lets a truly passive investor buy a single stock fund that invests in world equity markets.

Well, soon they will:

Vanguard filed a registration statement on Wednesday, April 2, 2008, with the U.S. Securities and Exchange Commission (SEC) to offer a global equity index fund—Vanguard Global Stock Index Fund. The fund will offer three share classes—Investor, Institutional, and ETFs—that are expected to be available in the second quarter of 2008. This will be Vanguard's first passively managed global index fund.

The new fund will seek to track the performance of the FTSE All-World Index, a float-adjusted, market capitalization-weighted index designed to measure equity market performance of large- and mid-capitalization stocks worldwide. The fund will invest in a broadly diversified sampling of securities from the target benchmark, which comprises more than 2,800 large- and mid-cap stocks of companies in 48 foreign countries. Approximately 55% of the index is made up of stocks from outside the U.S."

The index fund open-end version's 0.45% expense ratio is not as cheap as other Vanguard U.S. index funds, and is just 0.19% cheaper than Vanguards actively managed global stock fund, Vanguard Global Equity (VHGEX).

Vanguard is also adding purchase fees to buy the open-end version of this new index fund, along with the usual redemption fees:

To offset the transaction costs associated with global investing and to protect the interests of long-term fund shareholders, the fund will assess a 0.15% purchase fee on all non-ETF share purchases and a 2% redemption fee on all non-ETF assets redeemed within two months of purchase."

This front and back fee levy should lead to slightly better quoted performance of the open-end fund than the closed end fund, even factoring in higher fund expenses (the ETF costs 0.25%).

Vanguard is really just playing catch-up here. Barclays iShares unit just launched a global stock ETF, iShares MSCI ACWI Index Fund (ACWI), which started just last week. Barclay's fund owns 711 holdings to mimic an index of 2,884 stocks and comes with an 0.35% expense ratio - more than the Vanguard ETF but less than the Vanguard open-end fund.

Global indexing made more sense before foreign stocks outpaced U.S. stocks, as they have for the past several years. At this point we expect U.S. stocks to beat foreign stocks going forward. Our predictions aside, for those looking for a one stop stock fund they can buy and ignore for twenty years, this is it. No word on where the one stop global stock AND bond index fund is - we need that even more, especially in 401(k) plans.

Schwab YieldPlus Investors Run After Fund Goes PriceNegative

March 28, 2008

Ultra short-term bond funds have been collapsing since early July 2007, and the carnage is going from bad to worse. Apparently investors in these funds - billed as slightly higher risk alternatives to money market funds - are liquidating in droves:

Ultra-short bond fund Schwab YieldPlus (SWYPX) is the latest victim of the credit crisis. It has fallen 16.8% for the year to date through March 26, ranking dead last in its category, and as a result, investors have been fleeing the fund. Assets have fallen precipitously from a high of $13.5 billion in June 2007 to just $2.5 billion as of March 20.

The fund's sizeable loss in recent months is certainly shocking, as ultra short-term fixed-income securities are generally perceived to be safe investments with minimal interest-rate and credit risks..."

Schwab YieldPlus has fallen almost 20% since late January 2008 - four times more than the Nasdaq drop during the same period - which is particularly troubling because the upside of the fund was slim - perhaps 1% more than an investor would get in a traditional low-fee money market fund. As Schwab's website notes, "the fund’s objective is to seek high current income with minimal changes in share price. " This is the type of fund an investor might park some cash they need in a few months to pay for college tuition or to buy a house - or just to avoid the risk of the stock market or even longer-term bond funds.

Ultra short-term bond funds' trouble started last year. The adjustable rate mortgage and corporate debt these funds invested in was far riskier than the investment grade ratings would lead one to believe. The current trouble has as much to do with the open-end fund structure itself as with continuing home-loan and other adjustable debt mark downs: when investors panic sell all at once the fund manager has no choice but to sell portfolio holdings at the same time to raise cash - often at lower prices than the fund thought the holdings were worth.

Sudden increased selling by fund shareholders leads to lower security prices of the fund holdings which drives the fund price or NAV down even more, which in turn leads to more fund investors selling. As many of these types of funds have "Free, unlimited checkwriting" and all have no redemption fees, there is nothing standing in the way of nervous shareholders getting out. Selling at large funds like Schwab YieldPlus can drive prices down for other funds that own the same or similar securities as well. Mutual funds in such a death spiral will not come back to their original price even if the hard hit portfolio holdings rebound in price.

See also:

Why You Should Worry About Your Bond Funds
Is Your Bond Fund a Ticking Sub-Prime Time Bomb?

Fund Bad, ETF Good?

March 3, 2008

Fund Bad, ETF Good?

While exchange traded funds, or ETFs, are a useful invention, we fear investors will get into more trouble with them than they do with ordinary mutual funds. The primarily benefit - low costs and tax efficiency - seem to be falling to the wayside as the other benefits, intraday trading, leveraging, shorting, and ultra-targeting of sub-sectors and investment strategies, take the spotlight.

We've often heard experts opine on how bad mutual funds are compared to ETFs. This is a bit silly as the same mutual fund companies running "evil" mutual funds are usually the same companies behind ETFs. Moreover, to most investors, there is little difference between a Vanguard open end fund and its ETF cousin. In fact, to those buying in relatively small allocations directly through the fund company, ordinary index funds remain the cost effective choice, especially when an investor is adding money regularly.

In response to a reader question about a book called The Lies About Money by Ric Edelman, Eric Tyson, author of Investing for Dummies notes:

"A number of financial advisers are cheerleading for ETFs. In my observation, this advocacy is self-serving, because such advisers have investment-management businesses built around using ETFs. And, in a competitive marketplace, they want to be different and appear current to appeal to novice customers.

In Edelman's case, he has written a purposely provocative and hyped book telling his readers the following:

'The retail mutual fund industry is ripping you off. ... You need to sell all your retail mutual funds. ... The fact is that the retail mutual fund industry is now flush with liars, crooks and charlatans. Daily business activities include deceit, hidden costs, undisclosed risks, deceptive trade practices, conflicts of interest, and fundamental violations of trust — all at your expense. Since September 2003, the retail mutual fund industry has paid out more than $5 billion in fines.'

That does indeed sound pretty awful, doesn't it?

...What's ironic and hypocritical of Edelman's comments is that he said in a prior book, 'I hate index funds.' Well, ETFs are index funds that you trade on a stock exchange!

ETFs are similar to mutual funds, with the most significant difference being that in order to invest, you must buy into an ETF through a stock exchange where ETFs trade, just as individual stocks do.

Thus, you need a brokerage account to be able to invest in ETFs.

ETFs are most like index mutual funds in that each ETF generally tracks a major market index. (Beware that more and more ETFs are being issued that track more narrowly focused indexes, such as an industry group and small country).

The best ETFs might also have slightly lower operating expenses than the lowest-cost index funds.

However, you must pay a brokerage fee to buy and sell an ETF, and the current market value of the ETF may deviate slightly from the underlying market value of the securities in its portfolio."


Vanguard Tries To Ruin Your Investing Tax Break

February 14, 2008

You can count on mutual fund companies to try to squash any product they think is a competitive threat to their multi-trillion-dollar-in-assets cash machine.

The latest attack on mutual fund dominance is from the relatively unknown exchange traded notes (ETN). These ETF-esque securities are essentially exchange traded derivative contracts. The main force behind ETNs is Barclays iPath® Currency Exchange Traded Notes. With their popular iShares lineup, Barclays is already a big player in ordinary exchange traded funds (ETFs). So far the offerings are mostly focused on commodities and currencies. Still, according to an article on today, Vanguard is already trying to nip notes in the bud:

Barclays Plc introduced a new product that put a scare into Vanguard Group Inc. and the rest of the $13 trillion U.S. mutual-fund industry. Now Congress and the Treasury Department are coming to the funds' aid.

The security, called an exchange-traded note, allows individual investors to buy a type of forward contract linked to commodities and assets ranging from oil to currencies to foreign stock indexes. It has lower fees than mutual funds, is less regulated and, for now, lets holders defer taxable income indefinitely.

While less than $10 billion of the notes have been issued so far, mutual-fund companies see the potential for the new instruments to catch on in a big way with investors. The notes are 'derivatives for the masses,' said Alex Gelinas, a tax lawyer at Sidley Austin LLP in New York. For the mutual funds, reining them in is 'the issue of the year.'

The funds argue that the way the notes are handled for tax purposes puts their products at a disadvantage. The industry's trade group wants the government to either scrap the notes' favorable tax treatment or extend it to them too....In response, the Investment Company Institute [ICI], the trade association representing Vanguard and other funds, sent letters to Congress and Treasury calling the tax advantages of exchange- traded notes 'unwarranted, unintended and unfair.'

It got results. The Treasury Department in December said the interest income generated by currency-related notes can't be deferred because they are debt instruments. It may rule on other types of notes this year."

This is not the the first time funds acted to protect their best interests. In recent years fund companies were concerned people would buy professionally managed stock baskets without the inefficiencies, regulations, and costs of the old fashioned mutual fund structure, so they sicked their trade group, the Investment Company Institute, on small upstarts offering these services. Fortunately for fund companies, the idea never gelled with consumers as similar exchange traded funds became popular.


Why are ETFs More Tax Efficient Anyway?

January 18, 2008

You hear it all the time: exchange-traded funds are more tax-efficient than traditional mutual funds - what you don't hear is the reason why. Smartmoney gives a good answer:

When investors decide to exit an ETF they can sell their shares in the open market. In some cases, the authorized participant will redeem large chunks of ETF shares directly with an ETF sponsor like WisdomTree, performing what's called an "in-kind" redemption. In essence, they reverse the initial purchase transaction. So WisdomTree would return that sampling of individual shares in its portfolio to the AP in exchange for the ETF shares. The twist: WisdomTree will generally return the shares with the lowest cost basis — the ones it paid the least for and, hence, the ones with the highest potential capital gains — in order to hold down its potential tax hit. The AP doesn't care because its tax basis will be based on the current share price. The IRS perceives the whole deal as two companies exchanging one type of share for another, so it's not considered a taxable event.

That transaction method helps insulate existing ETF shareholders from unexpected capital gains — a luxury mutual fund holders don't enjoy. Indeed, an investor who leaves a mutual fund can potentially trigger capitals gains in their wake, since a manager has to sell shares to pay them off. Meanwhile, an investor who leaves an ETF pays taxes on his own profits; the existing shareholders don't get whacked with any unexpected capital gains."

Of course, non of this matters if you own your funds in a tax deferred account like an IRA.


To Tame Portfolio Upside, Consider Some Trendy New ETFs…

December 20, 2007

The Wall Street Journal’s personal finance guru Jonathan Clements is keen on some of the new fangled ETFs mutual fund companies are churning out by the fistful:

Wall Street has rolled out some 600 exchange-traded index funds, those stock-market-listed products that have exploded in popularity. Many, however, merely mimic existing mutual funds -- or are so narrowly focused that they're of little use to prudent investors.

But lately, all that's changed. ETF sponsors have launched intriguing funds in four key sectors, offering ordinary investors some great new ways to diversify"

The article notes the fabulous diversification offered by new ETFs investing in foreign real estate, international small caps, commodities, and foreign bonds:

Foreign Real Estate
iShares S&P World ex-U.S. Property (WPS)
SPDR DJ Wilshire International Real Estate (RWX)
WisdomTree International Real Estate (DRW)

International Small Caps
iShares MSCI EAFE Small Cap (SCZ)
SPDR S&P International Small Cap (GWX)
WisdomTree International SmallCap Dividend (DLS)

Shares S&P GSCI Commodity (GSG)
PowerShares DB Commodity (DBC)
iPath Dow Jones-AIG Commodity (DJP)
iPath S&P GSCI Total Return (GSP)

International Bonds
SPDR Lehman International Treasury Bond (BWX)

Adding these funds will add diversity: your boring U.S. stock, bond, and money market funds will go up in coming years while the new ETFs will go down. That’s diversity we can do without. the rest of this article»

Perplexed about ETFs?

October 29, 2007

According to InvestmentNews, most investors don't know the difference between a mutual fund and an exchange traded fund.

a recent survey of 500 individual investors by Rydex Investments of Rockville, Md., found that 53% did not know the difference between an ETF and a mutual fund. Thirty-eight percent of those surveyed didn't know what an ETF is."

Well here's the short answer: the key difference between an ETF and a mutual fund is that it can be bought and sold throughout the day (and can change in value throughout the day), like a stock. A mutual fund is priced just once, at the end of each day.

There are other differences between ETFs and mutual funds - like ETFs are not actively manged unlike most mutual funds. Some of the features investors find attractive about exchange traded funds are their low fees and a fund market price that, because of a complex arbitrage system, doesn't vary much from the actual fund NAV (or net asset value), a key shortfall of the other exchange traded funds: closed end funds.


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