Thread: ETF's

Hey Spaf- you wanna take a crack at answering this question about ETF's?

I had someone ask it in another forum- I haven't had time to mull over a good response yet, but I'll through it out here, and let you, or anyone esle who wants to pitch in a thought- to try and answer the question below:

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Originally Posted by RPM
James:

Do you know why there is such difference between $SPX and SPY on the P&F charts? TIA
You ask an interesting question.

I'll try and write something up in answer, and post it tonight in this thread:

ETF's

The sum of your question comes down to "Why don't ETF's perform exactly in line with the indexes they are supposed to represent?"

And that answer will take more than I can do here.
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Thanks in advance- gotta go.

Someone else may want to delve into this futher because I only know about a few spokes on this wheel but here goes. Two main reasons.

1. Fees, Fees, Fees, Fees, Fees. Even the most efficient ETF's have some kind of fee involved. SPY is probably one of the most efficient.
2. An ETF is a sample of the Index it attempts to represent. For example, the S&P 500 contains 500 companies but the SPY contains probably only about 100. The manager attempts to equally weight the ETF holdings to correlate with movements in the actual index. This is not always possible and may result in discrepancies with the actual index.

Don't get too excited about trying to capitalize on a discrepency in the actual NAV of an ETF vs it's current bid/ask. There are hundreds of Sharks in the Hedge Fund industry that make their money arbitraging ETF's in the same way that they arbitrage the Futures/Spot price/Index markets. In an ETF like SPY, the discrepancy between NAV and latest trading price might be ~.01% if you're lucky. When you're playing with millions of $$$ though, nickel dime trades over time do accumulate. If a shark sees that the SPY is trading below what they perceive to be it's NAV based on the current prices of it's holdings, they flood the system with buy orders. When it's trading above it's NAV, they flood it with sell orders. A constant tug-o-war amongst the big boys. Impossible for us Plebes to attempt as this is what's called Program Trading.

Example of how difficult is to arbitrage a highly liquid ETF: On 4/9/08 SPY had a NAV of 135.36 according to Yahoo. The closing price of the SPY that day was 135.83. The next day, 4/10/08, the SPY opened at 135.35 (very close to prior day's close NAV). SPY is a traders playground.

In the world we live in today where anyone has access to a trading account, opportunities for actual arbitrage are extremely rare. Burton Malkiel made big bucks loading up on Closed End Funds in 2002 as they traded at a discount of 10-20% below their NAV. (Hence the argument against the 'Efficient Market Theory'.) As more and more Hedge Funds rush into the game, this practice has become increasingly obsolete.

In summary, fees are the real killer. The S&P 500 is a mere mathematical equation that doesn't take into account the Bid/Ask Spread or Commissions when rebalancing it's portfolio.

Originally Posted by Bullitt

ETF's are a relatively new phenomenon and I wouldn't be surprised to see a few founder in the years ahead.

Chart courtesy wsj.com. "In the last two months, 21 ETF's were withdrawn from registration."

Looks like the alleged bear is causing investors to relinquish their lust for exotica.

It's a hard sell when the bear is knocking, unless it is a inverse ETF.

Inverse ETF's are an interesting option in today's market. I've been dabbling with some success. But I hesitate to put any substantial amounts into a company that isn't backed by "full faith and credit," such as FDIC insurance.

I'd love to get opinions on which "securities and investment" type companies the MB thinks are going to best weather this storm and be around in - - say - - five years. Which ones do you have the most confidence in that they're safer, well capitalized, well managed, etc.?

Anyone willing to offer an opinion?

Thanks,
Lady

In my opinion the Government isn't going to let anybody else fail that's TBTF after what happened globally with Lehman. Feel free to invest in ETF's at will.

I do caution investing in any low volume ETF's and ETN's, especially ETN's. ETN's don't invest in the underlying assets, but are backed by bonds and.... I really don't know how they work.

Look for good average volume before dabbling into any ETF. That's your best indicator of being 'safer' in regards to defaults.

This is no time to be messing around with 2x short funds if you're looking 5 years out. I'm still a believer in the global infrastructure story so a few good ETF's to consider with that respect would be
IGF: iShares Infrastructure (low volume though)
GII: Macquerie Global Infrastructure (very low volume)
SLX: Vectors Steel
MXI: iShares Global Materials
PHO: Powershares Water

Originally Posted by Bullitt

In my opinion the Government isn't going to let anybody else fail that's TBTF after what happened globally with Lehman. Feel free to invest in ETF's at will.

I do caution investing in any low volume ETF's and ETN's, especially ETN's. ETN's don't invest in the underlying assets, but are backed by bonds and.... I really don't know how they work.

Look for good average volume before dabbling into any ETF. That's your best indicator of being 'safer' in regards to defaults.

This is no time to be messing around with 2x short funds if you're looking 5 years out. I'm still a believer in the global infrastructure story so a few good ETF's to consider with that respect would be
IGF: iShares Infrastructure (low volume though)
GII: Macquerie Global Infrastructure (very low volume)
SLX: Vectors Steel
MXI: iShares Global Materials
PHO: Powershares Water

Thanks for taking the time to offer your thoughts! And I appreciate your confirmation of my opinion that the time for ultra-shorts has passed. I have been dealing lately with SH, SBB and EFZ and they have been treating me well. I'll take a good look at the ETF's you have suggested as well.

And who knows. The way the markets have been the last three days, the time for SPYders may not be far off!

My sincere appreciation! Thanks again!
Lady