ETFs Capture Market Attention & Investment
Andrew Leckey

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The momentum of exchange-traded funds, which attracted new investor money at a rapid clip throughout 2010, is expected to continue unabated in 2011.

Those ETFs investing in the appreciating commodities of gold and silver have been especially popular, but stocks and bonds are also attracting new money. The numbers don't lie:

-- More than $1 trillion is now invested in U.S.-listed ETFs, according to calculations by the BlackRock research group.

-- While still dwarfed by the $12 trillion in traditional mutual funds, ETF assets have grown at a 28 percent average annual clip over the past five years, according to Morningstar Inc. in Chicago.

-- There are now about 1,000 different ETF products, according to the National Stock Exchange, with new types of ETFs regularly being introduced to investors.

"Performance of ETFs investing in precious metals was outstanding in 2010, and, although emerging markets ETFs started slowly, they turned in an excellent performance for the year," said Ron DeLegge, editor of ETFguide.com in San Diego. "However, problems in Europe were much worse than anyone would have thought."

The SPDR Gold Trust ETF (GLD) has appreciated about 25 percent in value each of the last two years, while Vanguard Emerging Markets ETF (VWO) gained around 15 percent in price in 2010 after a 74 percent jump the prior year.

Besides diversifying an investor portfolio, these low-cost investments that hold baskets of stocks, bonds or commodities can be traded throughout the day like stocks. That differs from traditional mutual funds, whose prices are set once at the end of each day.

An ETF is tax-efficient, so you won't get stuck with a year-end capital gains tax bill as you might with a mutual fund in which other investors sold their shares.

"One of the biggest trends is greater education about ETFs, such as our own firm's educational campaign," said Anthony Rochte, senior managing director of State Street Global Advisors in Boston. "Indicative of ETF brand awareness is the fact that more than 30 percent of the NYSE/Euronext trading volume for the first half of 2010 was in ETFs."

Rochte's State Street Global Advisors, which offers the SPDR products, launched the first-ever ETF in 1993 with the introduction of the SPDR S&P 500 (SPY) -- still the largest ETF. Other major ETF players include BlackRock, which offers iShares ETFs, and Vanguard Group, which offers ETFs under its own name.

"Buying an ETF is more complicated than a mutual fund because there are bids and asks throughout the trading day, and market forces can affect price," explained Paul Justice, director of exchange-traded funds for Morningstar Inc. "Always make sure you know what the underlying stocks, bonds or commodities are worth versus what you're paying for the ETF."

What's hot for 2011?

Investors are especially interested in short-term fixed-income ETFs, said Rochte, with SPDR Barclays Capital 1-3 Month T bill ETF (BIL) gaining 30 percent in assets in 2010. The assets of SPDR S&P Emerging Markets Small Cap ETF (EWX) rose tenfold in 2010 as investors sought the attractive demographics and consumer demand of rising countries, he said.

Another trend in this low-interest-rate environment is the search for current dividend income, he added, with assets of SPDR S&P Dividend ETF (SDY) up nearly threefold during 2010.

"Just understand that an ETF is not a shield from volatility and that just because it is based on an index does not mean it has no risk," cautioned Rochte. "Understand the index the ETF is based upon, what stocks that index includes and expenses involved, or you'll be making a big mistake."

In setting a 2011 ETF strategy for an individual, DeLegge would first make sure major asset classes are represented through ETFs such as Schwab U.S. Broad Market (SCHB) and the previously mentioned Vanguard Emerging Markets ETF. For a diversified play on international markets, he recommends Vanguard Europe Pacific ETF (VEA).

A commodities choice for those concerned about inflation or a weakening U.S. dollar would be ETFS Physical Precious Metal Basket Shares (GLTR), which owns a diversified portfolio of gold, silver, palladium and platinum. In real estate, he recommends Vanguard REIT Index ETF (VNQ) and SPDR Dow Jones International Real Estate ETF (RWX).

Turning to bonds, DeLegge recommends Vanguard Total Bond Market (BND) and, for inflation-protected securities, SPDR Barclays Capital TIPS (IPE).

"For every investor, a model portfolio should include a mix of stocks and bonds, with a bit of commodity exposure between 4 and 10 percent that could be satisfied with a gold ETF," said Justice. "The reason that you don't see ETFs in 401(k) retirement accounts is that you'd have to pay a trading fee every time you invest, such as through payroll deduction."

Justice believes the easiest way to get exposure to all stocks domestically and internationally is through an ETF such as Vanguard Total World Stock Index ETF (VT). However, to get more focused stock exposure, he prefers Vanguard Mega Cap 300 Index ETF (MGC); Vanguard Mid Cap ETF (VO); and Vanguard Small Cap ETF (VB).

For exposure to developed foreign markets, Justice likes iShares MSCI EAFE Index ETF (EFA) and iShares MSCI EAFE Small Cap Index ETF (SCZ). His gold choices would include the previously mentioned SPDR Gold Trust ETF.

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