By Christian Magoon
CEO, Magoon Capital
The entertaining Discount Double Check commercials are in full swing each NFL Sunday as Aaron Rodgers, the beloved quarterback of the Green Bay Packers, endorses State Farm Insurance. ETF investors could take a lesson from the double check campaign as rechecking certain elements of an ETF before investing could help to avoid painful portfolio mistakes. Let's look at three areas to double check before purchasing any ETF.
Double Check #1: The Index
Never assume anything about an ETF until reading the index methodology behind it. Just like computers have operating systems that control their every move, the majority of ETFs have an index methodology running in the background. The index defines what the ETF can and cannot own and often includes limits on exposure to certain securities for example. A great example of why its pays to double check the index is found in BRIC (Brazil, Russia, India China) ETFs. There are three BRIC ETFs in the marketplace: BIK, BRK, EEB. Although they all focus on the BRIC countries, each tracks a separate index and produces different country weightings. For example, one index only owns stocks that trade on U.S. exchanges in the form of ADRs. This limits the index's exposure to Russia as few Russian companies trade as ADRs. Accordingly, less than 3% of the fund is exposed to Russia. In contrast, another BRIC ETF has 27% exposure to Russia as its index includes stocks traded in Russia. Understanding the two indexes prevents performance surprises and allows for better investment decision making.
Double Check #2: The Holdings
The name of an ETF can sometimes be misleading yet many investors don't go beyond it in their due diligence. For example, an investor who wants exposure to natural gas buys a natural gas ETF like the United States Natural Gas Fund (UNG) or the First Trust Natural Gas Index Fund (FCG). Do these natural gas ETFs hold the same securities? No way! There are natural gas ETFs that own futures contracts and others that own the stocks of businesses focused in the natural gas space. Doing a double check on the holdings of an ETF can alert you to these major differences quickly. How major are they? The difference in performance in the two ETFs over the last year has been 48 percentage points according to Google Finance.
Double Check #3: The Indicative Optimized Portfolio Value (IOPV)
The IOPV is a calculation by a stock exchange that approximates the ETF's net asset value (NAV) every 15 seconds throughout the day. Before placing an order to purchase an ETF, a worthwhile double check is to review the ETF's current share price and compare it to the IOPV. This gives investors an idea on where the ETF shares are trading in relation to the value they should be trading at. Knowing this can help ensure that poor pricing or execution is recognized before, not after the order takes place. The IOPV symbol can often be found next to the ETF ticker symbol on ETF fact cards. Here's an example from an iShares fact card:
BONUS Double Check: The Ticker
For some investors this bonus double check seems as intuitive as pressing the gas pedal - and not the brake - when driving. However, you'd be surprised how often our site, GoldETFs.biz, hears from investors who bought the wrong ticker! This often happens in leveraged ETFs where investors can access magnified daily exposure to market segments. Usually these ETFs have tickers that are fairly close. For example, we've heard of mix ups between gold ETFs GLL and UGL. Both are leveraged by 200% but one is bullish and the other bearish - big differences in performance and worthy of a double check.
Double checks are worthwhile as from time to time they uncover a small mistake, assumption or even a major error. ETF investors who implement the double check as part of their investment process will help to ensure a smoother investment experience.