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Editor's Note

by Charles Rotblut, CFA

Editor's Note Splash image

We have a big change to announce: James Cloonan has modified the Model Fund Portfolio to hold both mutual funds and exchange-traded funds. The Model Exchange-Traded Fund (ETF) Portfolio has been discontinued in conjunction with this change.

As Jim mentioned in the May AAII Journal, the Model ETF Portfolio was an experimental portfolio designed to examine what was then a new investment product. As exchange-traded funds have evolved, their role in a diversified portfolio has become more apparent. This led us to revise the Model Fund Portfolio to take advantage of the unique strengths of mutual funds and ETFs. You can see what is now included in the Model Fund Portfolio here.

Choosing between exchange-traded funds and mutual funds is not an either/or decision. Rather, the decision depends on the asset class you want to invest in and the strategy you want to follow. For pure stock index strategies, the very low cost of exchange-traded funds makes them very attractive. Bond indexes are difficult to mimic, and this is one area where active management should be considered, thereby giving an edge to mutual funds.

The ability to properly take advantage of a particular strategy is a good rule of thumb for deciding between using an exchange-traded fund or a mutual fund. As we note in this year’s ETF Guide, the number of actively managed ETFs is small, despite the successful introduction of the PIMCO Total Return ETF (BOND). The overwhelming majority of actively managed ETFs have less than $100 million in assets. This is why in situations where having an active manager makes more sense, mutual funds should be considered.

For many assets and strategies, however, exchange-traded funds are the better alternative. Not only do ETFs have lower expense ratios than their mutual fund counterparts, but they also offer more transparency about their holdings and can be bought and sold throughout the trading day. In addition, you can easily get direct exposure to specific markets, sectors and assets through ETFs.

One thing you have to watch out for when investing in ETFs is their market price. Exchange-traded funds, and exchange-traded notes, can trade at premiums or discounts to their net asset value. This means you could end up paying more than a dollar (bad) or less than dollar (good) for a dollar’s worth of assets. An example we use in the ETF guide is SPDR Silver Trust (SLV), which traded at both a 4.4% premium and a 3.4% discount in June 2012.

To help you identify those ETFs that have traded at premiums or discounts to their net asset value, we added a new data point to this year’s guide: 12-month market return. Displayed alongside the 12-month net asset value (NAV) return, this number shows how closely shares have tracked changes in their underlying assets. The larger the spread between the two numbers, the more often an ETF has traded at a premium or a discount.

We’ve expanded the number of ETFs covered in this year’s guide. You will find more than 450 funds covered in the print version, which starts here. In the online version, on AAII.com, you will find expanded data for 1,475 funds. As was the case last year, we’ve kept the category names and data similar to our annual mutual fund guide (published in the February 2012 AAII Journal), to make comparisons easy.

Contact information for the fund families is listed in the Hot Links column here.

Finally, to help you create a strategy for building your own ETF portfolio, I reached out to Max Isaacman, the author of “Winning With ETF Strategies” (FT Press/Minyanville Media, 2012). Max suggests that you start by identifying your investing objectives and tolerance for risk, and then decide what asset classes are appropriate. Once you have made these decisions, you will be able to narrow the list of ETFs to the ones most suitable for your portfolio. Max explains further here.

Wishing you prosperity
Charles Rotblut, CFA
Editor, AAII Journal
twitter.com/charlesrotblut

Charles Rotblut, CFA is a vice president at AAII and editor of the AAII Journal. Follow him on Twitter at twitter.com/CharlesRAAII.


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