ETF Update: Tax Efficiency, Commodity Volatility, Active-Management News, Tracking Target Date ETFs

Tax-Efficient ETFs

Exchange traded funds offer investors a cost effective path to access a large range of global markets. So, what type of costs should investors consider when investing in these funds? First off, because ETFs are bought and sold on an exchange like a single stock, each transaction is subject to the broker's fee, reports Joanna Ching for Financial Times. If you are making frequent transactions or working with small amounts, trading fees could eat into any gains over time. Also, ETFs have expense ratios that can drag on total annual performance, but they are minor in comparison to other funds.

Despite these fees, ETFs offer the lowest expense ratios than any other investment tool around. Annual expenses are deducted from any dividends paid out, usually on a quarterly or annual basis. As a rule, the more assets under management and the more interest there is for an ETF from investors, the more likely there will be a compression of fees.

Taxes offer another break with ETFs. In the U.S., ETFs generate fewer capital gains than mutual funds. Thus they are much more tax efficient.

Commodity Volatility

Commodity-focused ETFs are composed and perform differently than their equity-based cousins. Keep in mind commodity ETFs have different tax implications than the equity ETFs. Equity ETFs generate a capital gain or loss at the time the shares are sold and may (but not usually) have capital gain distributions at year-end.

Commodity-based ETFs with futures contracts generate tax bills yearly, based on the income generated from futures, such as when contracts are rolled over. Investors must pay taxes for an ETFs appreciation as if it was sold at the end of the year. Jesse Emspak for Investor's Business Daily reports that usually around 60% of the gain is treated as long term and 40% for short term.

The tracking styles of the two types of ETFs differ, too. Just because the market price of the commodity went up doesn't mean the ETF went up with it. The reason has to do with a relation of the physical commodity, the amount stored in inventories, and what investors expect to get delivered. This is where the volatility comes in that investors don't expect.

Knowing what you are buying is important, so do the homework and make sure the investment fits with your portfolio, investment goal and tax planning.

More Active-Management News

ETF have been building up to become one of the hottest investment tools available. Active management seems like it is the next phase of development on their upward journey. Product providers have yet to deliver the first true actively managed ETF, reports Rebecca Knight for Financial Times, they are the talk of every ETF conference around.

Currently, there is an onslaught of "semi-active" ETFs arriving to the market, which are basically alternative weighting strategies. Providers have been moving away from market capitalization and in this way many ETFs have evolved into somewhat of an active strategy.

The main issues with an actively managed ETF involve maintaining transparency, and cost effectiveness. The rest are technical details that can be worked out over time. But the question is do ETF investors want an actively managed ETF? Isn't the point of an ETF to follow an index?

Tracking Target Date ETFs

As billions flow into target date ETFs, do investors have the staying power? These types of investments are meant to be purchased and forgotten about until the desired date. How do you track and compare performance on target date funds? These retirement funds come in a wide array of styles, shapes and sizes, so how can you compare?

Lipper offers a rating based on past performance and are weeding out the ones with no proven track record. Kevin Burke for Ignites reports that the type of ranking system pits the performance of all 2030 funds against each other on a quarter-by-quarter basis, for the 12 quarters ending September 2007.

These are more conservative options, and the main problem is that investors feel they are underperforming when these kinds of funds lose money during a bear market. During a bull market, does greed take over? These target date funds may actually underperform because of the lack of diversification.