The Weird World of ETFs

(page 2 of 2)

3. Claymore MACROshares Oil Down Tradable Shares (DCR)

While the share price of an ETF changes constantly, its net asset value (NAV) is set only once a day. Because the two don't always match, an investor could buy an ETF at a premium to the NAV and sell at a discount, substantially lowering returns.

Claymore MACROshares Oil Down Tradable Shares has only traded near its NAV 11% of the time, according to Amex.com. Almost 60% of the time, the product has traded at more than a 2.5% discount to its NAV. Technically a trust, not a fund, this exchange-traded security tries to make money from the downward movements of crude futures.

S&P's Edwards has concerns about the product's low trading volume, too. "If an investor wanted to get out, they would need to offer a large discount to attract a buyer," says S&P's Edwards. He advises ETF investors against investing "in anything thinly traded."

Claymore MACROshares Oil Down Tradable Shares has posted year-to-date total market returns of 2.95%, beating the S&P 500 by 0.53 percentage points. The exchange-traded security has come under criticism for its expenses of 1.6%.

4. Internet HOLDRS (HHH)

Not all exotic ETF offerings are thinly traded. In fact, some aren't even new. Merrill Lynch (MER) introduced its first HOLDRS exchange-traded security baskets in 1998, and the HOLDRS' are often among the top-volume traders on the Amex.

Though generally lumped in with ETFs, the various HOLDRS are technically trusts, so they can't rebalance—or even add new stocks. As a result, the HOLDRS' holdings and performance may diverge markedly from those of traditional indexes tracking the same sector. Ron DeLegge, publisher of ETFGuide.com, observes, "Who in their right mind would want to own an investment product that's not rebalanced or not updated to properly reflect the sector it's supposed to be representing?"

The Internet HOLDRS comprises just 11 stocks, including Yahoo! (YHOO) and eBay (EBAY) but not Internet heavyweights like Google (GOOG), which came out after the HOLDRS debut. By contrast, the First Trust Dow Jones Internet Index Fund (FDN) ETF holds 40 stocks.

Investors may not be quibbling with Internet HOLDRS' performance, however. It has posted total annualized market returns of 14.42% over the past five years, beating the S&P 500 by 5.4%. On a one-year basis, though, Internet HOLDRS trails that benchmark by 23.18 percentage points.

5. iShares MSCI Belgium Index (EWK)

While Kazakhstan does not yet have its own country-specific ETF—sorry, Borat—many other countries, large and small, do. The iShares MSCI Belgium Index is one of the most unusual of them. That's no knock on Belgium, however. Not only are iShares MSCI Belgium Index shareholders investing in only a slim segment of the world market, but the fund's top five holdings make up 60% of the portfolio, creating even more potential volatility.

Still, the iShares MSCI Belgium Index can boast close to blockbuster-caliber performance. The ETF has posted total five-year annualized market returns of 23.91%, besting the MSCI EAFE index by 6.42 percentage points. It has an expense ratio of 0.54%.

This fund may be out of the ordinary, but there are still practical uses for exotic ETFs, says Tom Lydon, president of financial advisory firm Global Trends. "Individual investors and advisers are utilizing ETFs more for specific asset allocation and identifying changing trends in the marketplace," Lydon says. "The only concern is when individual investors get too enthusiastic about a sector or global region after the lion's share of its upside performance is behind."

Either way, investors should make sure they know what they're getting into if they're considering new and unusual ETFs.

Hogan is a reporter for BusinessWeek.com in New York.