The exchange-traded fund is maybe the fastest hit in the history of financial products. In the decade and a half since its inception the category has attracted $450 billion in assets. The ETF is a cross between a closed-end fund and an openend fund. It offers diversification, low cost, high tax efficiency and the convenience of trading on a stock exchange throughout the day.
What’s not to like? Plenty. Many of the 850 ETFs now vying for your attention suffer from one or more of the same cardinal sins seen in other Wall Street products: an excessively narrow focus, high leverage, misleading packaging and tax inefficiency. First Trust Global Wind Energy, for example, sells itself as a clean-energy ETF. But the pool of wind-energy producers is so shallow that it owns significant stakes in carbon polluters BP and Royal Dutch Shell just to maintain liquidity.
United States Oil Fund purports to track the price of West Texas Intermediate Crude Oil. The futures market in which it trades is so thin, however, that pros can front-run it each month, knowing that the ETF will have to roll over its positions. Two highly leveraged funds, Ultra Oil & Gas ProShares and UltraShort Oil & Gas ProShares, are supposed to move in opposite directions; they lost 74% and 30%, respectively, last year.
“If you’re hell-bent on using leverage for longer than a day, use a margin account,” suggests Paul Justice, a Morningstar analyst.