《Forbes》2006 Mutual Fund Survey
吴越教主请进：如果对ETF仍有兴趣。

★　你想投指数吗　　　　－－　Vanguard Large-Cap Index ETF
★　你想炒黄金吗　　　　－－　iShares COMEX Gold Trust
★　你想倒古董炒外汇吗　－－　有新出的ETF，不过你可得小心些。

Michael Maiello and Megan Johnston 09.18.06

They’re red-hot these days because folks assume they are cheaper than funds. That’s not always true. And some of the things ETFs track are getting a bit loopy. Here’s what to watch out for.

This is the day of exchange-traded funds. ETFs, baskets of stocks held in a fixed proportion, have three things going for them. They have low expense ratios, generally much lower than expenses on comparable open-end mutual funds. They are tax-efficient, minimizing capital gain distributions to holders. And they are very, very liquid. ETFs are traded as stocks, just like old-fashioned closed-end funds, but–unlike those closed-ends–can be counted on to trade at prices very close to their net asset values. ETFs can be bought and sold around the clock with a mouse click. Traders can place stop and limit orders on these securities, and even can short them. Not so with funds.

Small wonder that assets in ETFs, which began in 1993 as a curiosity, have grown wildly. In the 12 months ending in June their assets shot up 38% to $335 billion, according to the Investment Company Institute. Funds, at this point with much more assets ($9.3 trillion), are barely growing in net new entrants. This year through July 2006 investment firms–some of them fund companies like Vanguard–have launched 56 new ETF issues. That’s slightly more than debuted in all of 2005.

But hold on. ETFs’ cost advantage isn’t so clear-cut. In a number of cases, you’d be better off sticking to plain old mutual funds. Yes, the average ETF costs just 0.38% of assets yearly, versus 0.54% for index mutual funds and 1.12% for actively managed mutual funds, reckons Financial Research Corp. As with stocks, however, buying ETFs means paying broker commissions that can range between $10 and $50 per trade. The amount depends on the size of the trade, assets invested and whether one uses a discount or full-service broker. When buying a fund, unless you’re foolish enough to pay a sales load, the entry charge is zero.

That’s not all. Like other stocks, ETFs have bid-ask spreads. You’ll get nicked a little there if you go in and out.

So if you want to be in ETFs, the best strategy is to buy good ones in one lump sum and then hold. And as with anything else in investing, make sure that you are getting the cheapest ones possible, since fees over time will erode your returns. We have collected lists of some of the cheapest ETFs.

To offset the commission charge, an ETF owner must wait a long time, says Wilfred L. Dellva, an associate professor of finance at Villanova University. His study found that an online investor (whose trading fees usually are the cheapest) with $10,000 to invest must hold the ETF into the sixth year, and an investor using a full-service brokerage must hold the ETF for nine years to achieve any cost advantages over buying a no-load index mutual fund.

For $50,000 and $100,000 online investments, where trading commissions are a smaller percentage, the ETFs’ lower-cost advantage kicks in sooner for two popular issues that track the S&P 500: during the second year for the Spider, the third for the iShares S&P 500. Using a broker-assisted trade, it still takes a little longer than three years for the ETF to come out ahead.
Woe betide an ETF investor who wants to invest a little every month. That’s easy with funds, but a killer for stocks, even with a discount broker.

ETF owners seem to have the upper hand when it comes to the capital gains surprise. That’s the year-end gut punch that investors too often get from mutual funds, when a fund manager sells positions to get money for a better opportunity or simply to meet investor redemptions. Remaining fund holders get slapped with the cap gains tax from the sale. An ETF tends to be a low-turnover portfolio that tracks broad, well-known indexes like the S&P, the Wilshire 5000 or the Dow Jones industrial average. ETF managers don’t have to cash out investors (who simply sell their ETFs in the market) and thus aren’t selling appreciated positions in order to raise cash. So, presumably, ETFs don’t have much in the way of capital gain distributions.

Yet ETF owners aren’t totally exempt from a nasty cap gains surprise. Even indexes occasionally need to be rebalanced, as when companies get bought for cash and ETF managers need to sell underlying stocks, leading to cap gains for investors.
Some indexes are less static than others. Small-cap indexes have a built-in outmigration as member stocks’ market caps grow too large to be kept. Sponsor State Street’s StreetTracks Dow Jones Wilshire Small-Cap Value ETF was in the uncomfortable position of selling half its portfolio per year. State Street moved to mitigate the problem in 2005 by shifting the ETF’s benchmark from the Dow Jones small-cap index to a less turnover-prone one, the broad-market Dow Jones Wilshire 5000. Now turnover is 33%.

Meanwhile, in an effort to chase what’s hot (or at least exotic), money managers are latching onto ever-narrower benchmarks, or even creating novel bogeys whose worth has yet to be proven. In 2006 Rydex has introduced a line of currency ETFs, and WisdomTree has decided that indexes should be weighted by dividend payouts rather than market capitalization. New gold-mining and oil ETFs are loose on the land. You now can buy one dedicated solely to clean energy.

A special index developed by the American Stock Exchange, the spawning ground for ETFs, makes you question whether you’re in an index to begin with. The Amex calls this creature the Intellidex, which screens for companies, using 25 factors ranging from growth rates to valuations. And they change the lineup quarterly. Since the exchange keeps the innards of its system under a proprietary cloak, you have to trust them. The PowerShares Dynamic Market ETF, tracking the Intellidex, first came to market in 2003.

Here are some things to watch out for in various corners of the wonderful world of ETFs:

Equity Indexing

The Spider is currently the largest ETF in the U.S., with $56 billion. But Gary Gastineau, cofounder of Managed ETFs, a company that is developing actively managed ETFs, found that those tracking the S&P 500, as well as another popular index, the Russell 2000, underperformed their conventional mutual fund counterparts over the past ten years. The Spider fell short by a cumulative 1.2 percentage points during that time. A study by Edwin J. Elton, Martin J. Gruber and Kai Li of New York University and George Comer of Georgetown University came to a similar conclusion. Why the shortfall? Gastineau thinks index fund managers are more adept at rebalancing than ETF managers.

Another problem with the Spider: As the first ETF, it had to appease a wary SEC by organizing as something familiar–a unit investment trust, where dividends are paid out to investors. That brings a drag on performance, as the Spider can’t reinvest the dividends the way index mutual funds can.

In the past 12 months assets of global ETFs have nearly doubled to $83 billion, and they are a compelling alternative to closed-end country-specific funds. According to Morningstar, (nasdaq: MORN - news - people ) an international ETF will be cheaper than a closed-end fund just about every time, as these ETFs have an average expense ratio of 0.43%, while closed-ends charge an average 1.3%. Consider the excellent closed-end Spain Fund with its 16% five-year return that’s five points better than the MSCI EAFE. The fund charges a 1.65% expense ratio. The ETF version, iShares MSCI Spain Index, has a 16% return over five years but lower expenses: 0.59%.
Sometimes, though, open-end mutual funds do better than ETFs, particularly for regional or worldwide benchmarks. The iShares MSCI EAFE Index charges 0.36%, which is a good deal, but the fund alternative, the Fidelity Spartan International Index, charges 0.10% without a vexing brokerage fee.

Commodities and Currencies

Of the eight ETFs that track commodities, five of them have launched this year, which is to be expected, given the recent exuberance over inflation hedges like gold and oil. Some of them are not for the faint of heart. The iShares Silver Trust reached its peak of $148 in mid-May, two weeks after launching. A month later the ETF had lost 54% of its value, and now it is hovering around $120.

Two gold ETFs have been very successful. The larger one, the StreetTracks Gold Trust, has $7.7 billion in assets as of the end of July; $2.4 billion of new money has come in so far this year. The gold ETFs hold physical bullion, and the shares reflect the price of gold less trust expenses. Annual costs for both are 0.4%, not including commission charges. The other option is to constantly roll futures contracts at a brokerage. Do-it-yourself is a risky undertaking in the commodities pits for amateurs.
In terms of tax treatment, gains on this ETF are taxed only when you exit, but the shares are considered "collectibles," hence they are taxed at a maximum rate of 28% rather than the 15% long-term cap gains rate if held over one year. Gains on futures are taxed yearly, whether you sell or not, and are considered 40% short term (that is, taxed at ordinary income rates).

Two ETFs invest in a broad basket of commodities futures, the PowerShares DB Commodity Index Tracking fund and the iShares GSCI Commodity-Indexed Trust. Neither fund has an extensive track record. The PowerShares ETF, which is the elder of the two, began life in February; investors will pay up to 1.45% in fees per year. A cheaper mutual fund option exists in this category, the Pimco Commodity Real Return bond fund, which costs 1.24%.

In June a new option arose for commodities-seeking investors: exchange-traded notes, launched by Barclays (nyse: BCS - news - people ), branded under the iPath name. ETNs are debt securities that track indexes and trade all day on an exchange. Two ETNs, the iPath GSCI Total Return Index and the iPath Dow Jones-AIG Commodity Index Total Return, offer exposure to broad commodities benchmarks. A third, the iPath Goldman Sachs (nyse: GS - news - people ) Crude Oil Total Return Index, follows the price of West Texas crude oil futures contracts.
The ETNs carry annual expenses of 0.75%, but because they are so new, their tax implications are unclear. While Barclays says that ETNs should be subject to normal capital gains rules, others are skeptical. "If you’ve got futures involved, at the end of the year somebody is going to pay the taxes, and it’s not going to be the provider," says Thomas Lydon, president of Global Trends Investments in Newport Beach, Calif. and editor of the ETF Trends newsletter.

Earlier this year Rydex launched six new currency funds to complement its Euro Currency Shares (nyse: FXE - news - people ) ETF. With the Rydex products you can track any of six currencies from the British pound to the Mexican peso. They cost 0.4% a year. Buying these ETFs is akin to going long on that currency and shorting the dollar.

The same effect can be achieved, perhaps more cheaply, by simply opening a bank account in a foreign currency, which is easy enough to do online. Given that even Alan Greenspan has remarked that betting on currency directions is like gambling and that most international fund managers don’t spend time or money hedging their currency exposure, these products might be tempting, but useless, to the average investor. Our advice: If you yearn for a cosmopolitan flavor in your portfolio, get it by buying an international stock fund, and seek out one that does not hedge its currency exposure.

Bond ETF s Versus Bond Funds

Choosing between ETFs and bond index funds can be tricky. In the realm of fixed-income, fund fees tend to be lower and the tax benefits of ETFs are minimized because bond index funds rarely distribute capital gains. Further, ETFs are new to the bond arena, hence there’s scant evidence of their prowess.
The iShares Lehman Aggregate Bond Fund is an ETF that, as its name suggests, tracks Lehman’s bond index. The expense ratio is 0.2% and since inception in 2003 it hasn’t distributed any capital gains.

The Vanguard Total Bond Market Index fund is linked to the same index and also has a 0.2% expense ratio. The Vanguard fund has outperformed the iShares by a cumulative 0.6% since the ETF debuted. In its decadelong history, the Vanguard fund has distributed only 9 cents in capital gains (on shares now worth $9.80 apiece), a hit more than made up for by its outperformance. Vanguard’s $35 billion fund has been around since 1986, so it has a much longer record.

The $413 million Dreyfus Bond Market Index Fund has been around for 13 years and has slightly outpaced Vanguard’s fund over the last five. That’s because its expense ratio of 0.15% is the lowest of the bunch.

Paul Herbert, a senior fund analyst at Morningstar, writes that bond ETFs are a tool for "truly sophisticated investors [who] may get some benefits from trading ETFs intraday or short-selling them." Yet he then concludes that bond mutual funds are probably the way most long-term investors should go because right now their managers are more experienced and talented.

Star fund managers, like Pimco’s William Gross, are adept at spotting and exploiting inefficiencies in the bond market. This allows Gross to consistently beat the market. Nearly 10% of the 338 bond funds that track the Lehman Aggregate have beaten the index over ten years.

Strange Sectors

Morningstar senior fund analyst Daniel Culloton worries that this year’s glut of new ETF issues is just filling a banquet table with a lot of junk food that investors don’t really need. "They create more potential for pratfalls than for benefits," he says.
Beware of ETFs with especially narrow focuses like single currencies or obscure industry sectors. The point of ETFs is to offer broad diversification cheaply. When ETFs become too narrow, they lose their purpose. Morningstar says that 40% of the ETFs out there are sector-focused, compared to just 6% of mutual funds.

ProShares (a unit of ProFunds) recently launched 12 ETFs modeled on four common indexes: the Nasdaq 100, S&P 500, S&P Midcap 400 and Dow Jones. One set provides double the exposure to the indexes; one set provides inverse exposure to the indexes; one set provides double inverse exposure to them.
In May Claymore Advisors filed with the SEC to launch the Claymore-Sabrient Stealth ETF, which follows its own index of 150 stocks with little or no analyst coverage.

There was much talk, when ETFs started gaining notice in the late 1990s, about the death of mutual funds. Naturally, such chatter was premature. Mutual funds are no longer the best solutions in every circumstance, and it’s worth considering adding ETFs to almost any portfolio. But these tyro stock baskets certainly don’t have all of the answers.