So maybe that title is a bit much. I read an article (link intentionally not provided) about the quirks inherent in a couple of the more notorious exchange traded products that concluded with advice that these funds, one of them was US Natural Gas (UNG), "should be avoided by all but the most sophisticated investors."
I would come at this differently. Sophisticated is not the right word IMO. Generally speaking the typical person just trying to have is money grow in a reasonably diversified portfolio may not need UNG or the like but I think how a portfolio is constructed is mostly a function of how much time is spent on the portfolio.
Chances are the typical do it yourselfer with a full time job and a family won't have the time to manage a portfolio of 40-50 stocks, but of course he might. Jim Cramer offers a rule of thumb about needing one hour a week for each stock owned in a portfolio. While that idea is way too simplistic, some weeks need more than one hour and some weeks need close to no time (this is where news feeds can come in handy, oh Motley Fool article, never mind), it makes a point that time is needed to follow each holding.
In assessing these "sophisticated" funds it doesn't take a whole lot of time to get a decent sense of what a fund will be like. For example if a fund is going to own futures then it will be subject to the normal goings on in that market. At times contango is a big issue for oil for example--to the point of creating the appearance of the fund of "not working." Owning these funds requires an understanding of contango and backwardation and I think an understanding of the dynamics influencing changes in the degree of contango or backwardation or what would cause the market to go from one to the other.
Another example is the Macro Shares Housing Up and Housing Down products. In addition to having an opinion on the Case Shiller Index you also have to have opinion on the market's perception of that index.
Personally I don't want to spend time on any of that so I don't own the funds. The energy products can also be moved a lot by things having nothing to do with supply and demand (more so than other commodities).
Don't take the above as my saying you don't need to read the prospectus but I am saying it is not the first thing you need to read. Chances are a quick read of an article at IndexUniverse or Seeking Alpha is enough to know whether you have a general interest in learning more. Prospectuses are not fun to read so reading one for a fund you will never want to own seems unnecessary.
There are reasonably some things that could be difficult to foresee like being forced by a third party to halt creations. This has happened a couple of times and while a few years ago this may have seemed like something that would never happen we now know it can. The more complex the fund it would seem the the greater probability for some sort of problem in the future. Even if you can't guess what that problem would be you probably now know more about this than you did before.
The vast majority of ETPs I have used have been plain vanilla funds tracking baskets of stocks which have a lower probability of running into problems than do ETNs or futures based funds. We do hold PowerShares Agriculture (DBA) which is futures based and SPDR Gold (GLD) which owns bullion (I am not in the camp that believes they are lying about holding the bullion in vaults) so they have more of a chance, IMO, of having a problem at some point but I do think the chance is low.
If there were one fund that has future unforeseen problem written all over it I would think it would be the new iShares Diversified Alternatives Trust (ALT). A look under the hood is a little confusing as to what the strategy is. I have not read the prospectus yet (I may write about it for thestreet.com so a little prospectus time would be warranted in that case) but as I understand the product it is an actively managed go anywhere vehicle.
I'm not saying there will be a problem but there is a greater chance for one that with a generic equity fund.
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6 comments:
To oversimplify, trailing stops are your friend. Use this simple tool and the quirky movements in some of the "ETFs to avoid" and the volatility is flattened a bit. *We purposely own UNG on dips and sell on spikes, but protect ourselves with trailing stops. Meanwhile we enjoy terrific return in hot sectors/regions/asset classes.
*Disclaimer - we are a professional firm, don't try this at home unless you are very comfortable with the technique.
You're right, Roger. Most of us simply don't need products like these. A diversified portfolio of sturdy stocks and bonds, with good entry and exit strategies, will serve most investors very well.
I can't help but wonder if the development of products like these stems from the success that endowments had in alternative investments. I'd be surprised if many are still around in a few years.
you too can invest like Harvard has clearly contributed to this.
my point about the endowments all a long has been you can learn a couple of things about allocation from Harvard but you cannot invest like them. for example relatively simple and modest exposure to commodities has been a good thing.
Roger,@ 07:12,
One can say the same about Warren Buffet. You can learn a lot from him but you can't invest like him. You can however, invest with him and I can assure you; very profitably.
"relatively simple and modest exposure to commodities has been a good thing."
In my investment experience (25 years) commodites have actually been a lousy investment more often than not.
they've been pretty good for the last six or seven years. as for the last 25 years they had a low correlation to equities and gold went up a lot immediately after the 2001 terror event.
seems like they have don what they are supposed. i would stress, as i always do, a moderate weighting.
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