What's So Great About the iShares Broker-Dealer ETF?

I usually enjoy articles by John Spence at CBS Marketwatch. And for that matter, Mr. Spence did a fine job representing Morningstar’s John Gabriel on the potential positives for the iShares DJ Broker Dealer Index Fund (IAI). Nevertheless, I’d like to offer an opposing viewpoint on the “high risk, high reward” stamp of approval.

Analyst Gabriel is quoted as describing the iShares Dow Jones U.S. Broker-Dealers (IAI) as an "interesting satellite holding.” Gabriel notes that IAI has a tight correlation of 88% over 3 years with the S&P 500 and that it “…basically represents a levered play on the stock market.”

If it’s stock market risk that you want, why would IAI be better than an actual leveraged ETF of the market, like ProShares Ultra S&P 500 (SSO)? It seems to me that the leveraged fund has 45%-50% more reward for the levered risk.

To be clear, I am not advocating that investors use the leveraged SSO for a high risk, high reward outcome right now. I’m just posing a question. After all, if it’s leveraged market risk-reward that you’re after, you could use the above-mentioned SSO, could you not?

More importantly, if an investor simply goes for beta (market risk), the iShares Dow Jones U.S. Broker-Dealers (IAI) gets you into more trouble than the S&P 500 SPDR Trust (SPY). Here’s the bear-to-bull performance (10/9/07-Present):

So why exactly am I supposed to be intrigued with IAI as a potential satellite holding? By Mr. Gabriel’s own thoughts, iShares Dow Jones U.S. Broker-Dealers (IAI) isn’t providing any diversification. Don’t I want lower-correlating assets for my portfolio, assets that provide genuine “alpha” rather than market ”beta?”

Perhaps Mr. Spence and Mr. Gabriel like Goldman Sachs (GS). Goldman and Morgan Stanley (MS) together account for 20% of IAI’s direction. Or perhaps they believe in theoretical diversification, where you’re diversified because you’re getting many stocks that aren’t present in the S&P 500 SPDR Trust (SPY).

Practically, however, the iShares DJ Broker Dealer Index Fund (IAI) represents 1.67x the risk of SPY (according to RiskGrades.com) with very little actual diversification. In fact, one would garner LESS risk using Vanguard Emerging Markets (VWO) or SPDR Emerging Southeast Asia GMF (according to RiskGrades.com) rather than using the Broker Dealer Fund (IAI).

You’d also get MORE diversification with VWO or GMF. Indeed, you’d even get better performance.

Full Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. The company may hold positions in the ETFs, mutual funds and/or index funds mentioned above.

Comments

[The BT:]

What?

Oct 02 04:37 PM