Exchange Traded Funds (ETFs) have many benefits over stocks or mutual fund investments. But, watch out! There are definite land mines in this field.
The choice of ETFs has exploded in recent years. There are more than 1100 ETFs and ETNs (exchange traded notes) available to the US investor today. Other than trading an ETF based on the general market, there are ETFs based on international markets, those based on sectors, currencies, and even elements rarely heard of. Heck, there are even double and triple bull and bear ETFs that the retail investor may trade in a retirement account.
Because ETFs are based on a “basket” of investment vehicles, they are not at the mercy of an earnings report. Not only are fees associated with ETFs much less than those for mutual funds, but ETF positions can be traded throughout the market day. It’s ALL good, right? Not exactly, according to some ETF strategists. In a recent interview of a handful of these professionals, some mentioned “hidden tax consequences,” a lag in response to the market bias that the ETF represents, and other flaws based on the high risk vehicles underlying the named fund.
One specific example mentioned was UNG. This ETF invests in near month natural gas futures. As each month draws to a close, UNG rolls its position forward by selling the near-month position and buying a contract further from expiration. This helps the fund avoid taking physical delivery of the commodity. When the price of the longer-dated futures contracts exceeds the price of the front-month contract it causes a loss for the roll forward. This upward sloping forward price curve is also called Contango, and will be a drag on the performance of UNG. “UNG should be avoided at least until the natural gas price structure takes on a downward slope, i.e., backwardation , and the positive roll yield will become a tail wind,” says Sam Subramanian, editor of AlphaProfit Investment Newsletter, Sugar Land, TX.
The solution to the dangers of some ETFs?
As with any investment vehicle, do your own due diligence before you place your hard-earned money on the line. It’s your money. Know what you’re getting into!