Monday, June 04, 2007

ETFs 2.0

I was a little later than usual in getting my hands on the latest issue of MoneySense magazine this month, and I'm not sure what to think about an article on ETFs I read in it. (I can't find it available online yet, but it's on page 10 of the May 2007 issue, written by Duncan Hood.)

BetaPro Management -- a division of Jovian Capital Corp. -- has come out with two ETFs that essentially allow investors to bet on what direction the TSX is headed in. The Horizons BetaPro S&P/TSX 60 Bear Plus fund (HXD) is designed to provide bear market returns by betting that the market is headed down. The company also has a similar product designed to supercharge returns in a general bull market.

Essentially, this makes it easier for retail investors to short-sell the stock market.

Think the blue-chip-laden TSX 60 is headed down? Buy the HXD ETF. Every 1% loss in the index translates into a 2% gain in this ETF's value. But beware -- if you guess wrong and the index goes up, the value of the ETF will decrease, again, by twice as much. Theoretically, you could see your investment go all the way down to zero. And don't forget, the MER is above 1% -- a number that strikes me as being suspiciously high for an ETF.

My initial reaction was shock. I mean, this seems like a fairly speculative vehicle. But the more I think about it, I can perhaps acknowledge a limited role for this product in a conservative portfolio -- albeit a very small role.

Say you set aside a small percentage of your portfolio -- something under 10%, and put it into a product like this. With the TSX having been on such a good run for so long, we all know a pullback is coming at some point. So perhaps some exposure to this potential for gains in a down market could provide some sort of protection.

But sensible investors would limit this product to a small percentage of their overall portfolio. Anything more than that is just asking for trouble.

I'm not particularly inclined to jump in myself at this point, but I do think it's interesting for what it says about the evolution of the ETF: A vehicle that was originally designed to provide market-indexing at rock-bottom prices now includes variations of itself that actually do neither.


FourPillars said...

What I thought was a bit odd was that the ETFs have a 2:1 ratio on market movements. I guess that makes them more useful in that you don't need to buy as much but I would have thought that 1:1 movement made more sense?

Thicken My Wallet said...

An ETF is, at its core, a derivative- a vehicle that tracks the performance of another vehicle so I am not surprised someone put something out which is essentially gambling. Another sige that the market has hit the looney stage and its time to be defensive.