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Posted by on Apr 1, 2016 in ETF Strategist, Investment Perspective

Just In Time For April Fools!

Just In Time For April Fools!

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By Roger Nusbaum, AdvisorShares ETF Strategist

 

Quite a few years ago a blogger wrote an April Fools post about 100X levered ETFs. It was pretty good and fooled quite a few people. I tried to find it but had no luck.

I thought about writing a jokey post announcing some sort of outlandish suite of ETFs. We’ve kicked this sort of spoof around as maybe an ETF that of stocks that start with the L or companies east (or west) of the Mississippi. You get the idea but a jokey post like that is getting harder to do. There have been a couple of different runs at single state ETFs.

There have been some funds launched lately which seem incredibly narrow, along the lines of the health related funds from many years ago which included an endocrinology ETFs, an ophthalmology ETF and quite a few others before they were shuttered.

Personally, I love the innovation and enjoy learning about this sort of thing even if I am very unlikely to ever have interest in the Tungsten Miners ETF (TUNG)—April Fools, there is no TUNG ETF, not yet anyway.

When the endocrinology ETF came out Jack Bogle was very outspoken about what a terrible idea these funds were for the types of reasons you might expect related to speculation and risk. I probably don’t feel as strongly as Bogle, not by a long shot, but the narrower an equity ETF, the higher an investor should expect the volatility and/or risk to be. Just because the Splenic Order ETF (ok, I made that one up) is wildly volatile doesn’t necessarily invalidate it either but most advisors won’t want to expose clients to the unnecessary risk associated with such a narrow theme, even using individual stocks in such a narrow theme is very likely unnecessary.

In that last sentence I said “even using individual…” because it is quite possible that an ETF could be riskier than an individual stock. In a lot of these narrow biotech themes there will likely be a couple of winners and a lot of losers. Once a cure is found for Chiari-Frommel Syndrome (I’m looking them up now) then a lot of the stocks in that ETF are at risk of disappearing. Less dramatically this could play out as companies within a very narrow based fund competing for the same outcome such that the stock performance could offset and provide no value for fund holders.

ETFs are all that their proponents say they are in terms of diversification, access, transparency, liquidity and tax efficiency but they are not short cuts. Successful use of ETFs means understanding the strengths of what a given fund offers but also the drawbacks. ETFs can be the right tool for many exposures but no investment wrapper can be the best exposure for all things and all times. It is incumbent on the end user to learn the difference.

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