Two ETFs bit the dust last week—deservedly so. What was Geary Advisors LLC thinking when it launched state-focused ETFs? One targeted Texas stocks, the other held Oklahoma companies. Whatever the investment merits (and they were spare, at best, in my opinion), the marketplace has rendered its verdict. Apparently there are some products that are over the top, even in finance.
It’s not the first time that questionable ETFs have been launched, nor will it be the last time that we see marginal products die. But this pair looked far out on the edge, even in an age of dubious fund ideas. Why in the world would anyone want to target stocks solely based on where the headquarters are located based on the political boundaries of states? Countries, maybe; regions of the world, sure. Different asset classes? Absolutely. But states? No way. Let’s just hope no one starts inventing ETFs for counties and individual towns.
Issuing arbitrarily defined portfolios of securities is, in fact, old hat. Over the years, mutual funds and ETFs have been rolled out that hold only stocks that trade on a certain exchange, for instance. A more popular idea is designing funds that hold ridiculously narrow slices of companies within a given industry.
With the ETF business entering middle age, new products are increasingly and inevitably of marginal value, if any, vs. the current choices. The low-hanging fruit has been picked. That doesn’t mean that new funds from here on out are destined for mediocrity or worse. But the caveat emptor advice takes on greater relevance as financial companies struggle to grab a share of the lucrative ETF marketplace in an already crowded field. The new players are especially keen on creating a buzz, which often promotes bold new ideas. Experiments are great, but not with your retirement money or the company’s pension fund.
The bulk of the major asset classes are already represented by ETFs and mutual funds and so the argument for bringing out more often rests on thin ice. To the extent there’s a rationale for new launches it’s usually based on offering a lower-cost option for a given asset class vs. existing funds. Charles Schwab Investment Management’s recent entry into the ETF market focuses on offering competitive pricing in product areas that are already well established. The Schwab U.S. Broad Market ETF (SCHB), for instance, is less than a year old but it offers the lowest expense ratio of any broad-market U.S. stock fund available for retail investors: a mere 6 basis points, according to Morningstar Principia software.
There are also product launches that are productive by opening up formerly unavailable corners of the capital markets via indexing. For example, Van Eck Global in July launched the first local currency emerging-market bond ETF: Van Eck Market Vectors Emerging Markets Local Currency Bond (EMLC). And the recent arrival of two foreign corporate bond ETFs constitutes genuine progress by tapping into a broad swath of the global fixed-income market that was formerly unavailable via index funds for U.S. investors: SPDR Barclays Capital International Corporate Bond ETF (IBND) and PowerShares International Corporate Bond Portfolio (PICB).
But these are the exceptions to the rule these days. New funds with a raison d’être are increasingly rare. That doesn’t stop the financial industry from cranking out fresh products. Yet the existing population of ETFs is already quite extensive. For strategic-minded investors, in fact, the menu is too broad. One of the regular features in The Beta Investment Report is monitoring and analyzing the new ETF and index mutual fund arrivals in order to bring clarity and perspective to an increasingly dizzying array of options. The goal: creating (and occasionally pruning) a short list of the best ETFs and index mutual funds for each of the major asset classes. I also keep an eye on a few of the more compelling subcategories, such as small cap value for equities. But most of this work is excluding the vast majority of products that, for one reason or another, don’t deserve a spot at the strategic-minded investing table.
Keeping a short list of the best products across all the major asset classes is harder than it sounds as the ranks of funds proliferates and the definitions blur. But the fact remains: Most investors don’t need 90% of the 1,000-plus ETFs that populate Morningstar Principia’s database. Separating the wheat from the chaff, however, takes time. But it’s worthwhile, although not because it’s a means to an end. Rather, developing a short list of ETFs and mutual fund index fund products is merely the first *and essential) step in the harder and much more important work of designing and managing asset allocation. If you’re going to cook up attractive risk premiums in your investment pot, you need a solid list of the available ingredients and spices.
The critical factors for strategic-minded investing are: a) focusing on the interaction of the broad array of asset classes; b) monitoring/analyzing the trends within a given asset class; and c) managing the overall mix in a dynamic fashion to some degree. These are the tasks that should be emphasized. In practice, the world is generally consumed with other matters when it comes to markets and investment products.
Rolling out lots of new funds is a good business for Wall Street, of course. That’s old news. But so is the question: Where Are the Customers’ Yachts?
The good news is that there’s already a rich assortment of betas for building and managing multi-asset class portfolios. Even if you limited your portfolio to broadly based betas, the full range of risk profiles available for both buy-and-hold and trading-oriented strategies is more than sufficient to accommodate most individual investors and even a fair sampling of institutional portfolios. But as so often happens in the securities business, 98% of the attention is directed at the margins. It all makes for a good story in the financial media, but it’s got little to with cultivating investment success in the long run.
So, what else is new?