How to Understand Evaluate and Trade Exchange-Traded Funds

How to Understand, Evaluate and Trade Exchange-Traded Funds Dave Nadig Director of Research Index. Universe. com

Why ETFs? Intraday Trading Lower Costs Tax Efficiency Transparency Access To Anything

Why ETFs? Really? Creation/Redemption

Lessons from the Flash Crash: ETFs Are Complex Rydex S&P 500 Equal-Weight ETF (NYSEArca: RSP)

ETF Selection Matters Subsectors too: Three regional banking ETFs 66% spread in performance

Not Even All ETFs Tracking The Same Index Are Created Equal EEM vs. VWO: Same Index, Different Results

Sometimes, the ETF industry reminds me of the cereal aisle at my supermarket … Completely overwhelming.

Structuring ETF Choices: Three Decision Points Efficiency Tradability Fit

What’s Efficiency? Efficiency is how well a fund delivers on its core promise to investors.

What’s Efficiency? • Expense Ratio • Tracking Error • Optimization/Full Replication • Fund Structure • Tax Treatment And History • Fund Closure Risk • Credit Risk

What’s Efficiency? BND vs. AGG on Optimization BND AGG Issues in Benchmark 8, 717 Issues in Fund 3, 743 224 Fund Ex-Ante Tracking Error +/- 7 bps/year +/- 27 bps/year

What’s Efficiency? EEM vs. VWO on Tracking Error EEM VWO Expense Ratio 0. 72% 0. 27% Issues in Benchmark 756 Issues in Fund 623 849 Goal of Optimization Tax/Trading Efficiency Replication % Weight In Brazil 15. 34% 15. 55% % Weight In India 6. 96% 7. 93% 1 -Year Performance 18. 29% 20. 75% Holdings 4/30/10, returns through 5/31/10

What’s Efficiency? It’s Favorable Tax Treatment Product Category Long-Term Max Rate Equities 15% Bonds 15% Commodity ETFs (Futures) 23% Commodity ETNs 15% Next-Gen Commodity ETFs (Futures) 15% Commodity ETFs (Bullion-based) 28% Currency ETFs 35% Currency ETNs 35% Certain Wisdom. Tree Currency ETFs 15%

What’s Efficiency? It’s Fund Structure: Grantor Trust, 1940 Act, Commodity Pool, etc.

What’s Tradability? Myth 1: You Can’t Buy An ETF With Less Than $50 Million In Assets. 8, 300 = Average Daily Volume 145, 000 = Total Volume for the Day 92, 800 = Size of a Single Trade $4. 6 m (28%) = Growth in the Fund for the Day

What’s Tradability? Myth #2 a: An ETF is as liquid as its underlying Intelligent Limit Order (total volume during trade: 72, 600 shares) Sweeping The Book (total volume during trade: 43, 800 shares)

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What’s Fit? It means knowing what you own.

What’s the Market Cap of Wheat? Energy GSCI DJ-AIG DBCI RICI Industrial Metals Precious Metals Ags 1 -Yr Perf. 70. 88% 8. 80% 3. 08% 17. 14% 25. 87% 31. 46% 20. 92% 12. 89% 34. 73% 20. 53% 55. 00% 12. 50% 10% 22. 50% 17. 83% 44. 00% 15. 00% 6. 80% 34. 20% 31. 73% Data as of March 31, 2010

Evaluating Commodity Exposure For Fit: USO vs. Spot Oil

Conclusion