Assets of ETFs in the U.S. grew by 38% last year to $417 billion. There were 156 new offerings, which brought the total number of funds to 359. There are more and more ETF providers adding to the development pipeline every day, and each new ETF seems to have increasingly sophisticated approaches.
The benefit here is that you are provided with new strategies that were previously only available to highly sophisticated investors.
The downside is that while certain ETFs' strategies may be attractive, you may not always be getting what you paid for.
Take a look at Victoria Bay Asset Management's United States Oil fund (AMEX: USO). This famous ETF's benchmark is the spot price of West Texas Intermediate light, sweet crude oil delivered to Cushing, Okla., minus expenses. (I can actually hear some of you who've traded this one vomiting right now.)
The USO said it will invest in energy futures contracts, cash-settled options and other instruments including short-term U.S. Treasury securities. Millions of investors thought that this meant that it would track the price of light, sweet crude oil [WTI]. Can you blame them? When this ETF was launched in April of 2006, it was launched at the exact price that crude oil was being quoted on CNBC (I think about $69.00).
This was pitched by the media saying that "the USO's structure means that investors won't have to pursue such speculation on a contract-by-contract basis through the futures markets themselves. Instead, the USO creates a diversified pool of contracts and provides ease of entry and exit from one's position."
SUPER! But here's what happened if you bought it ...
When Light Crude was quoted right around $69.00 a barrel, this ETF was launched at about $69.00/share. But the ETF started underperforming Crude right away:
When Crude made it up to $77.95 in July 2006, this ETF only hit just under $75.00 (a 13% gain in Crude and 8.7% for the ETF).
By the end of July, when Crude dropped to about $61.00, this ETF was at $52.46 (an 11.6% drop in crude from $69.00 compared to a 24% decline in the ETF from $69.00).
But, as Crude tanked down to $50.00, the ETF made it down to $42.56! (a 27.5% drop from $69.00, compared to a 38.3% drop!)
USO was pitched by the media to the world as the ETF to own when you don’t know how to trade the actual Crude futures!!
What about the rebound? While investors who bought USO considered the possibility that maybe USO has larger swings (both up and down) than crude futures do, the fact of the matter is that USO rebounded from its low to its recent high by 11.64% while crude rebounded 14.1%.
So again, it was launched at $69.00 when Crude futures were at $69.00. As I write this (Wednesday, April 4th), Crude is quoted at $64.10 a barrel and USO is at $52.20. What a mess!