- The Washington Times - Friday, April 24, 2009

OPINION/ANALYSIS:

The financial and investing worlds both suffer from a number of similar problems including the one that drives the non-professional investor nutty, I suspect. I’m not talking about intricate trading strategies and complex instruments but rather all the acronyms.

There’s “PE” (price to earnings), “EBITDA” (earnings before interest, tax, depreciation and amortization), “DCF” (discounted cash flow), “WIP” (work in process) and a host of others, including “ETF” or exchange-traded fund. It is that last one, ETF, that has grown tremendously in not only product offering but in acceptance over the last several years and it appears that trend will continue.

While ETFs have been available in the U.S. since 1993 and in Europe since 1999, in May 2008 there were 680 ETFs in the U.S. with $610 billion in assets, an increase of $125 billion over the previous year per the Investment Company Institute. In the same month, a survey conducted by State Street Research and Wharton underscored how ETFs are changing the investment industry. Per the study, 67 percent of surveyed investment professionals called ETFs the most innovative investment vehicle of the last two decades, and 60 percent of these investment professionals shared that ETFs have fundamentally changed the way they construct investment portfolios. Needless to say, ETFs are worth paying attention to.

Perhaps the best place to start is at the beginning - exactly what is an ETF? In layman’s terms it’s a hybrid of sorts between a stock and a mutual fund. An exchange-traded fund is an investment vehicle traded on stock exchanges that offer investors an undivided interest in a pool of securities and other assets.

While they are similar to mutual funds, ETFs differ in that they can be bought and sold throughout the day, purchased on margin, sold short, and traded using stop orders and limit orders. As such, savvy investors can use them as part of a hedging strategy or a more complex strategy. Two other key advantages are tax efficiency and transparency, the former because the underlying securities are turned over far less frequently compared to mutual funds and other similar products.

Two of the more common ETFs are the Diamonds Trust (symbol DIA), which tracks the Dow Jones Industrial Average, and the SPDR S&P 500 (symbol SPY but more commonly referred to as “spiders”).

These respective ETFs hold the securities that comprise the indexes they are designed to mimic and trade at a fraction of the price of the indexes they represent. Since 1993, ETFs have proliferated and become tailored to an increasingly specific array of regions, sectors, commodities, bonds, futures and other asset classes. Some of the more prominent vendors of these products include Barclays iShares (www.ishares .com), Invesco PowerShares (www.invescopowershares.com), Rydex Investments (www.rydexfunds.com) and Vanguard (www.vanguard.com). Traditionally ETFs have been indexed funds; however, last year the U.S. Securities and Exchange Commission authorized the creation of actively managed ETFs through companies such as Bethesda-based Advisor Shares (www.advisorshares.com).

Do I like ETFs? Have I used them as part of my investment strategy?

I do like ETFs on a practical level and I have used them from time to time, primarily when I saw a certain sector or industry taking shape for a solid, sustainable move, but I could not narrow the choice to a particular company and its stock that I felt comfortable with. That was the case for my taking positions that were both long (in simple terms, betting that a security’s price would rise) as well as short (betting the security’s price would fall).

The ETFs that I have held positions in have included the Financial Select Sector (SPDR), SPDR S&P Homebuilders (XHB), iShares MSCI Emerging Markets Index (EEM) and the Consumer Discretionary Select Sector (XLY).

The last two are good examples of how I have effectively used ETFs. EEM offers exposure to emerging global markets without having to pick a particular country or even more specifically a particular company in that country. At the same time, several months ago when I was concerned about disposable income and the consumer’s ability to spend I took a negative stance on XLY, which gave me more or less blanket exposure to companies that were susceptible to a slowdown in consumer spending. To say the least, those ETFs offered me exposure in what I would call a “rising tide lifts all boats” scenario.

Will I use ETFs again? Odds are I will. Is there a danger that the uniqueness of ETFs gets blurred as more and more products are brought to the market? My suspicion says yes, but that doesn’t mean we can’t find solid candidates that are poised to benefit from all the data and investment mosaics for which we keep our eyes and ears open.

&#8226 Chris Versace is the founder and portfolio manager of SlipStream Capital Management LLC based in Reston. He can be reached at [email protected] times.com. At the time of publication, Mr. Versace had no positions in the companies mentioned in his column, although positions may change at any time.

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