Some of the newest exchange-traded funds tend to have the best returns initially, but historically speaking, they often become tarnished and see those returns drop precipitously.
That history lesson should remind advisors that they need to carefully consider the past performance of the managers of new ETFs earning high returns, and often that means looking at those managers’ performance with mutual funds, observers say.
“Since many of the new actively managed ETFs do not have long track records, it is best to review the past performance of the manager,” said Philip S. Blancato, chief executive and president of New York-based Ladenburg Thalmann Asset Management. “Investors should take the same due-diligence approach they take with any mutual fund they’ve invested in prior.”
All sorts of new ETFs are surfacing, with more than 50 categories of investments, including ones focused on currency, particular geographic areas and leveraged structures, as well as others that use socially conscious screens. But almost none of the novel ideas come without risks.
Some of the new “hot” ETFs are currency-hedged, adding another element of volatility and investment considerations that advisors and clients should recognize, Blancato said.
“At the end of the day, people should invest in ideas and areas of the market that they understand that fit their risk tolerance,” he said.
“Many of the new products on the market that have performed well are not for everyone,” Blancato said, citing ETFs with single-country exposure and hedged currencies. “Despite the new product proliferation, investors should still focus on the key tenants of why ETFs were built in the first place: transparency, liquidity, cost and efficiency.”
Nicholas Reisenbichler, product manager of mutual funds and alternative investments at Louisville, Ky.-based Hilliard Lyons, agrees that advisors must proceed cautiously when it comes to new ETFs.
Many of the newest ETFs that have been gaining popularity are smart beta, using additional data to outperform indexes.
“These represent a new hybrid,” Reisenbichler said.
Morningstar estimates that smart-beta products account for more than 20% of the $2 trillion in assets accumulated in U.S.-based ETFs.
The new types of funds are attractive, but precisely because they are new, they require investors to “look more closely at the underlying names,” Reisenbichler said.
Miriam Rozen writes about the financial advisory industry and is a staff reporter for Texas Lawyer.
This story is part of a 30-30 series on smart ETF strategies.
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