ETF Update: ETF, CEF Trial By Fire, Profiting From Market Volatility, Similar ETFs That Aren't, European, Int'l REITs ETFs,

Topics included in this update are: ETF, CEF Trial By Fire; Profiting From Market Volatility; Similar ETFs That Aren't; European ETF Demand Rises; Increased Interest In Int'l REITs ETFs.

ETF, CEF Trial By Fire
The recent turbulent markets have given many new ETF their first performance test. ETFs that track broad stock-market indexes performed as expected. Narrowly-focused ETFs and ETFs that use complex strategies to enhance an index's gains gave mixed results, says Eleanor Laise for the Wall Street Journal.

Leveraged ETFs that magnify market movements were among the biggest winners and losers. The UltraShort Russell MidCap Value ProShares (SJL) ETF that aims to produce twice the opposite of the daily performance of the Russell Midcap Value Index was up 25.2% for the month that ended Aug. 16. However, the Ultra Basic Materials ProShares (UYM) that tries to produce twice the daily performance of the Dow Jones U.S. Basic Materials Index dropped 27.7% during the same time period.

ETFs that focus on the housing market such as the iShares Dow Jones U.S. Home Construction (ITB) and SPDR S&P Homebuilders (XHB) suffered a severe blow. In addition, some ETFs that appeared similar on the surface had different results. For example, the iShares FTSE/Xinhua China 25 Index (FXI) dropped 10.5% for the month while the PowerShares Golden Dragon Halter USX China Portfolio (PGJ) dropped 13.9% for the month.

These ETF results show why it's important for investors to know and understand what's in their ETFs and how it affects their performance.

Market volatility has not been so good to closed-end funds CEFs. Many CEFs have been suffering losses up to 15-20% off their summer peaks, reports Steven Syre of The Boston Globe. CEFs tend to be sensitive to downturns when financial markets get shaky. Share prices suffer if no buyers materialize, and the underlying investments are at risk. CEF shares are well below their net asset value.

Provider Eaton Vance raised billions for highly anticipated rollouts of income-oriented CEFs that aimed for income at 9% per year. Unfortunately, these funds have only suffered losses. Pioneer's Diversified High Income Trust is down 22% since the end of June and Evergreen's Global Dividend Opportunity Fund is down 20% since July, at only 4.5 months old.

Profiting From Market Volatility
When the markets throw you lemons, make lemonade, as the situation has soured and ETFs are plentiful enough to take advantage of a bearish situation. Since ETFs trade like a stock throughout the day, it is possible to sell them short or buy on margin. Zoe Van Schyndel for The Motley Fool points this out as one way to make lemonade.

Short or ultrashort ETFs seek to give investors the inverse performance of market benchmarks. They tend to have high expense ratios, so beware that these don't eat up the returns. Also remember that when the market heads up, these ETFs will head down, that's just how they work. The "ultra" provides the double opposite of what the market is doing. One example is the ProShares UltraShort S&P 500 (SDS).

These ETFs and strategies aren't for everyone, make sure you know what you are getting into.

During a tumultuous time in the market, diversification helps keep the market and ETFs working for investors instead of against them. What happens on Wall Street doesn't necessarily stay there in this day and age, with Europe, Asia and other markets correlated with U.S. stocks, says Jonathan Burton for The Wall Street Journal.

The main thing investors should consider is how much of each asset do they want to utilize? Below are some ideas for diversifying an ETF portfolio:

U.S. Stocks - asset classes and sectors

Overseas developed and emerging-markets

U.S. bonds

International bonds

U.S. REITs

International REITs

Narrowly-focused sectors

Commodities

Currencies

Similar ETFs That Aren't
ETFs are known for their diversification among many other benefits. When selecting an ETF to cover a particular sector or region, investors need to ensure they understand the differences and similarities in ETFs that cover those areas.

For example iShares S&P GSTI Software (IGV) and Software HOLDRs (SWH) both look as if they invest in software, right? While that's true, SWH has returned an average annual gain of 12.5% over the past five years and 7% over the past three years, underperforming the market in both cases, says Selena Maranjian for The Motley Fool. IGV on the other hand, has gained an average of 16% over the past five years and 13.8% over the past three, topping the market by nearly 3% over five years.

What accounts for the vast differences in performance is each ETF's holdings? When choosing an ETF, investors need to examine what the holdings are and how much they're weighted to see if the ETF matches their investment goals. For example, SWH has 13 holdings with 22% going to Microsoft (MSFT). IGV spreads its assets over 40 holdings and 35% of the weight is divided among its top five.

IGV vs. SWH 1-yr chart:

European ETF Demand Rises
Now that the ETF trend has caught on, it seems everyone can't get enough of them. Jennifer Grancio, managing director and head of distribution for iShares Europe says that the European market for ETFs grew by about 60-70% last year. The U.S. market grew about 40% during that time, reports Ronan McCaughey for Global Pensions. With this growth comes some healthy competition. Let the ETF times roll!

Increased Interest In Int'l REITs ETFs
Now that U.S. real estate ETFs dropped sharply as mortgage problems spread, investors are closely watching international real estate ETFs. With U.S. REITs such as the Dow Jones Wilshire REIT ETF (RWR) down 10.3% so far this year, interest in the SPDR Dow Jones Wilshire International Real Estate (RWX) increased, according to John Spence for MarketWatch. Picking up on this trend, other ETF providers recently launched international REIT ETFs.

One of the easiest ways to participate in the market is through real estate investment trusts (REITs). These publicly traded companies, which were established by the U.S. government in the 1960s, own and operate commercial real estate properties such as apartments, offices and warehouses. Be aware that international REIT ETFs are not without risk, so ensure they fit with your investment goals before purchasing. RWX, for example, is down 7.9% year-to-date.