The Big Picture for the Week of 10/10/10

A big deal, rightfully so, is being made over the news that TD Ameritrade will offer no commission on 100 ETFs provided they are held for at least 30 days. Matt Hougan has been writing about ETFs having no commissions or expense ratios (instead they would make money lending stock out Matt says). I believe four discount brokerages offer some form of commission free ETF access and more and more funds have expense ratios under 0.10% (these are broad based funds) so Matt is on the way to being correct.

This commission free business represents part of an evolution in the space that I started talking about a long time ago--I would note this was and is a very obvious conclusion to draw. The path I saw was the access to many parts of the market that for one reason or another are not easy to access and there is plenty of potential new access in the pipeline (like fisheries) and new strategies (hedge fund replication and so forth) still to come. I never really thought about commission-free or zero expense ratio but these developments are all the better.

There are drawbacks of course. ETFs drew a lot of criticism in late 2008 when various markets were seizing up, there was also criticism in the face of the flash crash in May, we've gotten a hint of problems, more like proper expectations so far, with commodity ETFs due mostly to contango but whatever past issues have popped up anyone using the products should expect future issues. Useful though they may be they are investment products and throughout history investment products have encountered difficulties. I've made a point out of reminding people of this.

"Encountered difficulties" does not mean deathblow, IMO. At least one of the ETFs we use printed at a penny during the flash crash. To use an example I've used before it was obvious that a fund with a $50 NAV at 2pm was not worth a penny 40 minutes later--I had no concern that the fund was worthless. During some future market malfunction something similar might happen again (or not) but if it does the people that will get hurt are the people who panic. During the flash crash it was only a matter of minutes for prices to right themselves. Even if the next malfunction takes longer to right itself, a fund zeroing out one day is not a realistic concern.

Hopefully by now we have had enough ETF closings (PowerShares announced ten more on Friday) that everyone realizes that the consequence is simply a taxable event (depending on the account). If you own a fund that is announced as going to be closed it is probably better to sell right away but if you don't you will simply get cashed out at the NAV.

To reiterate the positives as I see them, a bunch of broad based equity exposure has not cut it in quite a while and will not cut it again until the next 17.6 year up cycle (or whatever you might believe in along these lines). For fixed income I don't think treasuries have cut for an investment for a while for being very expensive (they have been great trades for people looking for that) and there is a good chance that yields will stay low for a while (not my base case but many very smart people say otherwise). To repeat about treasuries; they are very expensive but of course could stay expensive for a long time.

On the equity side I write about about specialized or narrowly focused or niche funds for building equity exposure. At a minimum I think people need to figure out how to use broad based sector funds. Here decisions can be made about foreign versus domestic, cap size (remember PowerShares has small cap sector funds) and of course sector weightings versus your benchmark. If you can be comfortable with these types of decisions then it is not too big of a leap to something like using a defense contractor ETF as part of your industrial sector exposure (as an example from our portfolio--we prefer a common stock however).

This topic has been covered many times here with similar examples but I believe it is that important. The various countries, segments, themes and so on offer enough opportunity for "normal" returns over the course of the new decade that domestic broad indexes may not. Plenty of countries, and I would add individual stocks, offered normal returns from 2000-2010 and if the US is way below normal again I promise you there will be countries that again offer "normal" returns even if the countries in question are different from the ones who did the job in the last decade.

The other day I mentioned that Van Eck filed for one bond fund for Latin American countries and another for Asia ex-Japan. GlobalX is also thinking about getting into the fixed income space and while there is no detail from them yet given that they offer equity access to lithium and Chinese energy stocks I doubt their first bond fund will be a me-too ten year US treasury fund.

For many years I've been talking about foreign fixed income and hoping for single country access. While we are not there yet the news from Van Eck and Globalx is a big step in that direction. Over the last few years we have had good luck with Norwegian and Australian sovereign debt and while this is difficult for individual to access it should be made available in ETF form one way or another. Also important I think, are the Guggenheim BulletShares--these are the corporate bond ETFs where the funds target maturity of a specific year like 2015. With rates low in the entire bond complex it makes sense to manage duration very precisely. While anyone can buy individual US corporates not everyone may want to.

There will be new exposures in foreign fixed income like Australia, Norway and Chile and in equities why not a toll road ETF, airport ETF (or more broadly all types of ports) or a cement ETF?

The tools are there to be used smartly or misused by professionals and do-it-yourselfers. Assuming you need a "normal" return this decade, or something close to it you need to learn more about this than you currently know. This applies to everyone.