Do you know what’s hiding in your ETF?
While large index-based funds, such as those that track the Standard & Poor’s 500, may fairly represent the index’s stocks, smaller niche exchange-traded funds don’t always deliver strictly what their names promise, and you might wind up indirectly buying a lot of something you didn’t really want.
This doesn’t mean you should avoid ETFS entirely. But if a tightly focused investment is what you’re after, you have to know what’s in your fund.
If you want to figure out what’s really in an ETF, you’ll have to dig beyond its name.
What’s going on?
The more money an ETF has, the more it will be forced to chase larger companies, since these stocks can more easily absorb the dollars flowing in. But there’s a limited selection of large, liquid companies. And, these companies tend to operate globally, so only small percentages of their revenue come from any one country. It ends up being hard for an ETF to get “pure” exposure to, say, Spain or the U.K.
What can investors do?
You can find out much of what a fund does own, because each ETF details its top 10 stakes, including names and position sizes.
But you’ll have to dig deeper — into the EDGAR database on the Securities and Exchange Commission website, for example — if you want to determine how much business a company does in a certain niche. That defeats much of the purpose of this kind of ETF: speed and simplicity.
With so many funds investing in the same large companies, you might end up with a bigger allocation to one company than you want. So if you’re looking to ETFS for diversification — or for a precisely targeted investment — read the fine print first.