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AAII Investor Update: Don't Overpay for ETFs
Thursday, March 24, 2011
Charles Rotblut, CFA
AAII Journal Editor

AAII Resources

Navigating the ETF Waters
Find out what to look for, and what to avoid, in an ETF.


AAII Asset Allocation Survey
Are you favoring stocks, bonds or cash right now?



Discussion Boards
How Do You Decide Which ETF to Buy?

Most Popular AAII Articles

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It is possible to overpay for an exchange-traded fund (ETF). Two recent examples of excessive valuations involve Egyptian and Japanese ETFs.

As of Wednesday’s close, Market Vectors’ Egypt Index ETF (EGPT) was trading at a 2.3% premium to its net asset value. This is down from Tuesday’s premium of 5.7%. Net asset value (NAV) is the worth of the basket of assets the fund is designed to track. In the case of EGPT, it would be basket of securities with exposure to Egypt.

Last week, IndexUniverse.com, a news source on ETFs, noted that Japanese ETFs closed at premiums of 7% or more to their net asset values. This included iShares MSCI Japan (EWJ), which has an average daily trading volume of 45 million shares. In other words, this is very actively traded fund.

Since investing is messy, there are a few caveats to be aware of. The first is the difference in time zones. The Egyptian and Japanese markets are open during different hours than the U.S. markets, resulting in some fluctuations in the funds’ pricing relative to NAV. (Both funds hold securities traded on foreign exchanges.) Secondly, changes in currency rates also play a role. These two factors may partially explain why EWJ was priced at an eight-cent per share premium to its NAV as of Wednesday evening.

It should also be noted that Egypt’s stock market has had a difficult time reopening. On Wednesday, the bourse opened for the first time since January 27. Stocks quickly plunged, prompting a halt in trading. (Egyptian stocks ended the day down 8.95%.) Today, the market fell 5.5% before circuit breakers kicked in and suspended trading for 30 minutes. (A circuit breaker is a rule designed to stop trading when prices move by a certain magnitude over a specific period of time.)

Egypt is a special situation because of the recent government ouster. The drop in the Egyptian markets also shows the risks of investing in a country-specific emerging market ETF.

What I want to point out to you this week, however, is the importance of paying attention to an ETF’s net asset value before purchasing it. Though most ETFs do trade very closely to their NAVs, discrepancies can and do happen. A minor difference (e.g., a two-cent difference on an ETF that trades at $50 per share) is not very significant; a measurable premium is. In such cases, you are simply overpaying for no reason.

(This same logic also applies to closed-end funds, which are more likely to trade at notable premiums or discounts to their net asset values.)

You can find the current net asset value on a fund family’s website. For example, information on EWJ is available at www.ishares.com. You should also spend time reviewng the fund’s holdings and its prospectus.


BE SELECTIVE WITH ETFs

Fund families continue to come up with new ideas for ETFs. One of the latest is the ProShares Short High Yield ETF (SJB). This fund is designed to return -100% of the Markit iBoxx $ Liquid High Yield Index during a single day. In other words, if the index declines by 1% on a given day, SJB should rise by 1%. (Holding the fund longer than a single day can result in tracking error, which is a return that is not correlated with the underlying index.)

One of the inherent problems with such ETFs is that they are too specific for individual investors. For example, unless you are day-trading high-yield bonds, there is no need to own SJB. EGPT, SJB and other similar niche ETFs are examples of what I like to call “just because you can trade it, doesn’t mean you should” funds.

David Fry, publisher of the ETF Digest newsletter, explains why ETF sponsors are eager to introduce niche ETFs and provides strategies for building an ETF portfolio in How to Safely Navigate Through Crowded ETF Waters. AAII members can also consult our annual ETF Guide for a comprehensive listing of ETFs.

When looking at ETFs, what criteria do you use to determine which one to invest in? Tell us on the AAII Discussion Boards.

ASSET ALLOCATION SURVEY—WHAT ASSET CLASSES ARE YOU HOLDING?

Our monthly Asset Allocation Survey tracks how AAII members are allocating their portfolios. If you have not yet taken the survey this month, please do. It’s quick, and the results help us. Plus, once you are done, you can see how other members are allocating their portfolios. Take the survey

THE WEEK AHEAD

Just five members of the S&P 500 are scheduled to report earnings. Apollo Group (APOL), Lennar (LEN) and McCormick & Company (MKC) will report on Tuesday; Family Dollar Stores (FDO) will report on Wednesday; and CarMax (KMX) will report on Thursday.

February personal income and spending and January pending home sales will be the first economic reports to be released. Both are scheduled for Monday. Tuesday will feature the Conference Board’s March consumer confidence index and the January Case-Shiller home price index. The March ADP employment survey will be released on Wednesday. Thursday will feature the March Chicago PMI report, February Factory orders and the March Monster Employment Index. The March ISM manufacturing survey, March jobs data (including the change in nonfarm payrolls and the unemployment rate) and February construction spending will be published on Friday.

Several Federal Reserve officials are scheduled to make public appearances. Atlanta Federal Reserve Bank President Dennis Lockhart and Chicago Federal Reserve Bank President Charles Evans will speak on Monday. St. Louis Federal Reserve Bank President James Bullard will speak on Tuesday and Wednesday. Kansas City Federal Reserve Bank President Tom Hoenig will speak on Wednesday. Richmond Federal Reserve Bank President Jeffrey Lacker and Federal Reserve Governor Daniel Tarullo will speak on Thursday. Philadelphia Federal Reserve Bank President Charles Plosser will speak on Friday.

The Treasury Department will auction $35 billion of two-year notes on Monday, $35 billion of five-year notes on Tuesday, and $29 billion of seven-year notes on Wednesday.

Finally, Thursday will be opening day for Major League Baseball—a sign that warmer weather is coming our way.

AAII SENTIMENT SURVEY

Sentiment Survey

This week’s AAII Sentiment Survey results:
  Bullish: 37.7%, up 9.2 points
  Neutral: 27.3%, down 4.1 points
  Bearish: 35.0%, down 5.2 points

Long-term averages:
  Bullish: 39%
  Neutral: 31%
  Bearish: 30%

Take the AAII Sentiment Survey »


Bullish sentiment rebounded 9.2 percentage points to 37.7% in the latest AAII Sentiment Survey. This is a five-week high for optimism about the six-month direction of stock prices. Nevertheless, bullish sentiment continues to stay below its historical average of 39%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, fell 4.1 percentage points to 27.3%. The historical average is 31%.

Bearish sentiment, expectations that stock prices will fall over the next six months, declined 5.2 percentage points to 35.0%. Even with the pullback, bearish sentiment remained above its historical average of 30% for the fifth consecutive week.

The percentages of individual investors describing themselves as bullish or bearish remained close for the fourth time in five weeks. The lack of a clear signal is a reflection of the market’s recent volatility. Though this week’s rebound in stock prices helped restore some optimism, the latest survey results show that many AAII members continue to have cautious attitudes.

This week’s special question asked AAII members whether domestic or global/foreign issues were having a bigger impact on their sentiment. The responses were evenly split, with some members saying both domestic and international events were having an equal impact.

Here is a sample of the responses:

  • “Domestic issues—I think our economy is coming back, and the various threats are not likely to be strong enough to reverse this.”
  • “It is the labor markets, housing and the lack of political will to reduce the budget and adopt policies to improve the economy.”
  • “The financial markets in the European Union are a continuing threat to growth in the overall global economy.”
  • “With the problems in the Middle East, the disaster in Japan, and our unstable economy, I see nothing but an unstable market.”
  • “I am amazed at the resilience of the market given all of the bad news; it just keeps bobbing up like a cork.”

Are you bullish, bearish or neutral? Take the AAII Sentiment Survey and tell us.