Iâm glad to see a big publication pick up the theme because
the characterization is largely correct.
Watching some of the sector ETFs that have been rolled out
recently has left me wondering who could possibly want to invest in
them. The Global X Fishing Industry ETF (NYSEArca:FISN) springs to
mind as an example, but there are plenty of others.
The proliferation of these funds isnât just a harmless side
effect of the meteoric rise of ETFs. I fear that they fail to
provide many of the benefits of more traditional index ETFs.
To be fair, these niche funds arenât exactly a new
phenomenonâfunds that have turned out to be too granular for
investors have come and gone in the past. The textbook example is
the HealthShares line of 19 ETFs that was shuttered back in 2008.
Apparently their Metabolic-Endocrine Disorders ETF wasnât the hit
theyâd hoped it would be.
So, given the history, why the push into increasingly narrow
market slivers featuring less and less of the diversification
touted by ETF issuers?
Probably the best explanation of the situation comes from Rick
Ferri, who says in the WSJ piece:âItâs like throwing Jell-O
against the wall; some of it sticks.â
ETF issuers may have simply resorted to a process of natural
selection to determine what works in the market. The occasional
left-field product that scores bigâlike the Market Vectors Rare
Earth/Strategic Metals ETF (NYSEArca:REMX) that has garnered nearly
$245 millionâmay be worth the four or five funds that donât
make it.
As I mentioned in a previous blog, it seems likely that many of
the funds on the market today wonât survive for the long haul,
simply because over a third of all ETFs have less than $16 million
in assets.
Thatâs not a huge issue because fund closures are relatively
painless, but it does hint at the âsee what sticksâ mentality
among ETF companies that Ferri is talking about.
So, the lingering question here is why do some of these products
take off?
The answer seems to be that the old stock-picking instinct has
come to haunt the index fund world.
The popularity of niche-industry ETFs is largely due to
investors looking to outsmart the market by choosing industries
they believe will outperform. To my knowledge, thereâs no
evidence that investors can reliably do this.
And while itâs true that even narrowly defined ETFs offer
diversification benefits beyond buying a single stock, they do so
to a far lesser extent than normal index funds. Often the vast
majority of the weight in niche ETFs is in just 10 names.
So, while the occasional niche ETF may be a big winner for
issuers, it seems likely that investors chasing the latest hot
industry will for the most part lose out, just as they do when they
try to pick individual stocks.
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