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ETFs
All ETFs Are Not Equal
by InvestorGuide Staff (Write for us!)
(Click on the links within the article to get definition of that word)
ETFs have become very popular with institutional investors over the past decade or so. Only in the past couple of
years have ETFs started to become
attractive investmentoptions for retail investors as well.
Part of the reason why more investors have yet to include ETFs in their portfolios is because they can be a bit
confusing at first. ETFs were originally designed to track popular indexes like the NASDAQ 100 and deliver similar
performance for investors. Unlike indexes, however, ETFs are traded on exchanges and their prices fluctuate throughout
the day - in other words, they trade like stocks.
Unit Investment Trusts, or UIT's, were the first of the ETFs and the big names for this type include: Spiders, Midcap
Spiders, Diamonds, and Cubes. All of these ETFs were created by the American Stock Exchange which continues to be
the most popular exchange for ETFs. All of these ETFs were designed to track the major indexes like: S&P 500,
S&P Midcap, Dow Jones Industrials, and the NASDAQ 100.
The most common ETFs are produced using an open-end fund. These open-end funds are created according the rulesset
forth in the Investment Act of 1940. This basically just means that ETFs reinvest dividends automatically so there
is no worries about tracking errors like with the UIT's.
ETFs of the open-end fund type track a number of indexes (the major ones as well as the less popular ones).
Some of the open-end ETFs track specific marketsectors as well. With the exception of the fact that dividends
are reinvested automatically, open-end fund ETFs function and trade in the same manner as UIT's. Some
of the more
common ETFs from this type include: iShares, Streettracks, and Powershares.
VIPERS
Vanguard Index ParticipationReceipts, or VIPERS, are ETFs that were created by Vanguard. VIPERS are a very different
kind of ETFs because they are actually a class of Vanguard index funds. This can create a problem because of
the regulation that states "capital gains must be distributed across all shareclasses."
Therefore, there is potential for exposure to capital gains when shareholders own other Vanguard mutual funds.
Vanguard attempts to negate the capital gains by selling off losing investments through the
creation/redemption process.
HOLDR's
Holding CompanyDepository Receipts, or HOLDR's, are ETFs marketed by Merrill Lynch. These specialized ETFs are created
as grantor trusts and offer a number of advantages over the other types.
HOLDR's are usually created using a basket of 20 related stocks. The baskets are all unified in theme and contain
stocks from any number of highly specialized industries or sectors, including: B2Bservices, Internetarchitecture, biotech and any number of nichemarkets. Once the basket is complete, the stocks will not change for
the life of the ETF unless there is a bankruptcy, merger, or some other factor causing the business to cease
operations.
What is truly unique about HOLDR's is the fact that investors are considered to be owners of
the underlying stocks
in their basket. This means that investors are able to vote and receive dividends. In addition, an investor
can "un-bundle" stock from their basket and make a non-taxable exchange (sell off bad investments and buy more
good ones to offset potential capital gains). Of course there is a small fee for this un-bundling, but the tax savings
are usually more than worth the charge.
The four different types of ETFs all offer varying degrees of investment performance and each comes with specific
tax implications. The right ETF for any specific investor will depend upon their needs and investment objectives.
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