An ETF to Avoid?

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Followers of exchange-traded funds (ETFs) know that ETFs have exploded in popularity in recent years. They know that ETFs carry some compelling advantages for investors over stocks and funds. And they know that companies that issue ETFs, in their efforts to grab every dollar they can, have come out with ever more such offerings, many of which are so narrowly focused, they're almost ridiculous.

Make room for the brand new FocusShares ISE-REVERE Wal-Mart Supplier Index Fund (NYSE: WSI). Why would you want to invest in a basket of companies that are suppliers to Wal-Mart (NYSE: WMT)? I suppose the fund believes that Wal-Mart is huge, is growing bigger all the time, and that suppliers will grow along with it. Indeed, according to a press release, "In back testing for more than three years, the new WSI ETF has significantly outperformed the company stock and has more closely correlated with Wal-Mart sales than Wal-Mart's stock price, thereby giving investors another access point into this pivotal market leader."

The components of the fund span the retail industry. There are shares of game-maker Activision (Nasdaq: ATVI) and food companies Del Monte Foods (NYSE: DLM) and Kellogg (NYSE: K). You'll also find Hanesbrands (NYSE: HBI) and Mattel (NYSE: MAT) among its holdings.

I have a few problems with this investment, though:

• Sure, the index may have beaten Wal-Mart's stock. But remember that Wal-Mart stock has pretty much been stagnant for several years now. (Trust me -- I'm a shareholder.) Its long-term past offered great appreciation for shareholders, and its future may be the same, but over the past five years, it has just barely broken even after dividends. So it's no great feat to have beaten that.
• Next, these companies share a significant dependence on a single major customer: Wal-Mart. In my book, it's a worrisome thing if a company relies too much on one customer. If Wal-Mart stumbles, so do these firms.
• Finally, remember that Wal-Mart is not known for being an easy buyer to deal with. It's very demanding of its suppliers. It wants low, low prices that it can pass on to its customers, and the considerable pressure it puts on suppliers similarly squeezes their bottom lines.

Invest in this fund if you want, but be careful. Rolling back prices may put a smile on Wal-Mart's face, but its suppliers can't always say the same.

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