I have a confession to make. A few weeks ago, I sold the only exchange-traded fund that I have ever owned. I have been a fan of ETFs for some time, but I'd never found a compelling vehicle until I bought a piece of ProShares Ultra Technology
I have never been a fan of index investing, but I was intrigued by the fund's premise of attempting to double the return of the Dow Jones U.S. Technology Index, before expenses. The ETF does this by leveraging itself with derivatives such as swaps and futures, along with owning the actual components of the index.
Some of the largest U.S. Technology Index stocks include Google
Cheap is an opinion
So far, so sweet. So why did I sell? Well, it didn't take long for me to notice the illiquidity of the shares. The ETF traded just 200 shares the day it went public. The average day sees roughly 4,000 shares trading. And believe it or not, there have been 13 trading days in Ultra Technology's brief tenure on the market that have gone without a single trade taking place.
Lack of liquidity usually produces fat spreads between the market prices to get in and out, and the fund proved to be no different. Just minutes before the closing bell rang yesterday, the bid price sat at $76.92 and the ask price was at $77.22. That 0.4% difference may not mean much if you're in the "buy and hold" mold, but ETFs are often appealing to aggressive traders who can appreciate the concept of an index fund that trades throughout the day, instead of conventional funds that are typically priced just once at the end of every trading day.
So it's ironic that ETFs are often marketed on the basis of their low expense ratios, especially if they are marketed to market timers. Yes, ETFs can be cheap. You can find some trading with expense ratios as low as 0.07%. However, it gets far more expensive than that if you're a bit trigger-happy. If your plan is to try to time the market with ETFs, the reasonably low management fees get padded with bid-ask spreads on every round-trip trading trek.
We also can't blanket all ETFs as having low expense options. ProShares runs some pretty exotic funds, but they are also usually slapped with a 0.95% expense ratio. That isn't cheap at all for an index fund, unless you pit it against pricier actively managed stock funds or large hedge funds.
Too many ETFs, too little time
ProShares isn't the only company to unleash a ton of new funds this year. With hundreds of ETFs to choose from these days, one has to wonder whether supply is outstripping demand.
If you thought that my former fund's trading was light, ProShares has a consumer-services sector fund that has traded in just four of the past dozen trading days!
Not all ETFs are that obscure, of course. The PowerShares WilderHill Clean Energy
So I can't say that I am ready to swear off ETFs completely. I just think there are too many opportunities with international closed-end funds trading at steep discounts and so many excellent conventional managed mutual funds for me to dive again into the ETF pool anytime soon. At least I'll wait until my swimming trunks dry off.
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Longtime Fool contributor Rick Munarriz continues to own a pair of mutual funds and a Chinese closed-end fund that trades at a discount. It's just ETFs that he is avoiding, for now. He does not own shares in any of the companies mentioned in this story. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.
