Back to school with ETFs
Heading back to school, the “refresher course” is an old standby for teachers (along with “what I did on my summer vacation”). A similar exercise could be useful for ETF investors, who may at times feel a little overwhelmed with all the news coming out of the ETF world.
It wasn’t that long ago that choosing an ETF was pretty simple: there were just a handful of funds available and most focused on providing exposure to a broad asset class – the S&P 500, Europe, or emerging markets, for example. Now there are thousands of ETFs and the strategies have become more complex. You can invest in individual countries, in fixed income (all along the yield curve), in market niches ranging from medical devices to blockchain, and, increasingly in funds that are weighted to provide exposure to particular characteristics of stocks or bonds that are believed to lead to outperformance – so-called “factor-based” ETFs. Through July of this year, all this activity helped drive nearly $150 billion of inflows into U.S. Exchange Traded Funds.1
But more isn’t always better. In looking over this increasingly complex investment landscape, it’s also important to keep first principles in mind: what are the individual’s long-term goals? How does the strategy behind an individual ETF help meet those investment objectives? What ETFs best add value to the portfolio? There are multiple ways to employ ETFs but starting with these questions provides the basis for reviewing the available options and deploying ETFs in a portfolio in a way designed to take full advantage of their unique characteristics.
ETFs can serve a wide variety of purposes – providing diversification, exposure to specific markets, assets classes, and strategies, and the potential for enhanced returns and downside risk mitigation. Available strategies range broadly and might include merger arbitrage, tax exempt or taxable fixed income, additional income generating assets like real estate, small cap stocks, liquid alternatives, and international stocks and bonds. In combination with other broad-market holdings these can be used to provide income, build exposure to faster-growing asset classes, and potentially help mitigate downside risk. Factor-based ETFs can further fine tune exposures and add diversification.
As an investment product, the ETF structure has been a great innovation for investors, offering transparency, low cost, and intra-day liquidity, among other benefits. These qualities are shared by nearly all ETFs. But not all ETFs are equally useful to all investors in every circumstance. Just adding an ETF to an existing portfolio is not really a strategy. Understanding portfolio dynamics and investor objectives, and then selecting an ETF (or ETFs) to augment returns and manage risk in service to the individual’s long-term goals is the educated way to maximize the potential of these funds.
1. Divine, John, “6 Hidden Risks of Index Investing,” www.finance.yahoo.com, August 21, 2018.
The information and opinions contained herein are for general information use only. New York Life Investments does not guarantee their accuracy or completeness, nor does New York Life Investments assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. There can be no guarantee that any projection, forecast, or opinion in these materials will be realized. Past performance is no guarantee of future results. It is not possible to invest directly in an index.
All investments are subject to market risk, including possible loss of principal. Diversification cannot assure a profit or protect against loss in a declining market. Investors cannot invest directly in a benchmark.
Factor Based Investing is a strategy that chooses securities on attributes that are associated with higher returns. There are two main types of factors that have driven returns of stocks, bonds, and other factors; macroeconomic factors and style factors.
S&P 500, or Standard & Poor’s 500 Index, is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies by market value and is one of the most common benchmarks for the broader U.S. equity markets.
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