Are ETFs Safe or Insured?

by: Carl T. Delfeld

A natural concern of and common question by investors about exchange-traded funds is are they safe, guaranteed or insured? In other words, are they structurally sound?

ETFZone has a good Q&A piece that addresses this issue as well as some other common ETF related questions.

Here are some excerpts:

There appears to be little risk of abuse of the ETF structure as an investment vehicle. In the U.S., the Securities Exchange Commission thoroughly examines any application to create an ETF, and only large and closely watched firms are allowed in on the creation and redemption process of an ETF certificate. Finally, the same government agency (the Depository Trust Clearing Corporation) that ensures that individual stock certificates end up in the right investor's hands after a trade also ensures the ETF certificates are assigned correctly in a trade. In a decade of trading billions of dollars worth of ETFs, to our knowledge, no US investor has ever lost money from fraudulent ETFs.

The risk of the underlying asset is quite another matter. There is no guarantee that the underlying assets in an ETF will perform as the investor expects. An ETF is merely a basket of securities and each security will fluctuate with the market. Each asset class must be examined separately, and risk profiles of assets may change over time. Stocks are clearly risky, and ones in technology or emerging markets particularly so.

Long-term bonds will flucuate with interest rates and asset classes like real estate, precious metals, and are also risky in their own way. Short-term investment grade bonds, however, have generally proven quite safe.

A good rule of thumb for ETF investors is never to invest in an ETF unless you look to see what securities are in the ETF basket.

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