Exchange Traded Funds (ETFs)

  • Pros
    • Passive, low cost index trackers – i.e. SPY
    • Such ETFs track major country, sector, and bond indexes
    • Cash instruments make things simple, pay for what you want to buy and have a linear payoff
      • Trading futures, options, swaps, forwards and other derivatives creates complications
  • Cons
    • Anyone can create an ETF and charge whatever they want
    • Assets under $1B are considered tiny and stay away from anything less than $100M
      • Don’t be more than 10% of the daily traded volume
    • Make sure the ETF isn’t actually an ETN – i.e. USO
      • An ETN is a structured product and unlike ETFs, they do not hold the actual product
      • Commodity ETNs will trade futures instead of the physical product
        • The time factor of the futures instruments will over time create a very different return curve than the underlying, i.e. USO vs Spot Oil has underperformed significantly in the past
  • More Cons
    • Avoid leveraged and inverse ETFs
      • If a long ETF is flat over x number of days you will have lost money on the short ETF
      • At best, an instrument for very short term speculation
    • Extremely difficult to model short side of ETFs as it is nearly impossible to account for funding costs or availability

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