ETF Market Expanding with Narrower, More Expensive Funds

As the exchange-traded-fund market attracts more and more capital, fund offerings galore, no matter that some of the latest ETFs are having a tough time to launch. "Despite a lot of talk about how tough it is to get ETFs off the ground, there are still plenty of new offerings in the pipeline", comments Lawrence Carrel on, "At least 363 ETFs and exchange-traded notes are currently in registration with the Securities and Exchange Commission, according to That's more than half as much as the 561 on the market right now, according to Morningstar".

“The ETF market has become more than a place to invest in broad indexes at low cost”

"All of this competition is making it harder for ETF sponsors to attract seed capital to assemble the shares necessary to start trading. Up until now, this funding has come primarily from a group of elite stock traders, known as the specialists." The specialists are market makers. With ETFs, for example, following the dictates of supply and demand, they buy the component stock to assemble new shares, or dismantle shares to sell the underlying stock. "This can be a profitable business for ETFs that trade heavily. But it's much less attractive to make a market in ETFs that have little trading volume."

The new offering are plentiful because they are increasingly narrow. The ETF market has become more than a place to invest in broad indexes at low cost. It includes now many sector and subsector funds, such as PowerShares Global Water Portfolio (PIO), WisdomTree International Real Estate Sector Fund (DRW) and First Trust Industrials/Producer Durables AlphaDEX Fund (FXR). There are now several leveraged ETFs, and short too, such as Proshares Ultra Technology (ROM) and UltraShort Basic Materials (SMN).

The survival of niche funds is under question. Nevertheless, this is not bad news for their holders, as exchange-traded funds can be swiftly dismantled by the specialists into their component assets. Therefore, unlike closed-end funds, they maintain most of their net-asset value even if there is a lack of interest in the fund.

Yahoo News reports that "many firms have rolled out increasingly narrow, specialized ETFs. The new ETFs have been more expensive than their peers that track the S&P 500 or other broad indexes." According to a spokesman for Barclays Global Investors "the effect of high fees is muted by the fact that most investors don't go for the narrower ETFs." As Yahoo says, "the newer ETFs, tracking subsectors, are mostly sold to advisors and are not designed for individual investors to buy large positions. Because ETFs can be bought and sold like individual stocks, they can get an investor exposure to a sector without buying a mutual fund."

To summarize, the good news is that we have more and more ETFs to choose from, although the survival of many new offerings is yet to be seen, but that doesn't imply any significant risk for investors. Most of the new niche offerings are tailored for professionals, but small individual investors may use them for some cautious speculation, without losing too much diversification as it would be the case with buying individual stock. But keep an eye on expenses, as the narrow funds tend to have much higher ones than what the good old broad ETFs have got us used to.

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