Investors continued to embrace exchange-traded funds this year, as many of the best ETFs of 2013 produced huge returns for their shareholders. But even with stock markets soaring over the course of the year, the worst ETFs of 2013 delivered equally substantial losses to their investors, showing the dangers of ETF investing in trying to go through thousands of ETFs to try to avoid those with bad prospects.
Of course, the worst ETFs of 2013 might well turn out to be the best ETFs of 2014 if conditions play out right. Regardless, it's useful to look at the worst-performing ETFs during the past year to see what crushed their returns so badly and whether they're likely to keep struggling in the next year and beyond.
What didn't work in 2013
Among the losing funds in the ETF universe, volatility-linked exchange-traded products were among the worst performers of all. Even excluding leveraged products that had even worse losses, the unleveraged iPath S&P 500 VIX ST Futures (VXX) fell 66% during 2013, as the stock market continually defied calls for imminent corrections. For years now, volatility levels have remained extremely low, and the futures-based investing method that the iPath products use creates even bigger losses than the fall in the S&P Volatility Index that it's designed to follow. Until a lasting spike in volatility comes, the iPath ETF will have trouble rebounding from its huge losses.
The precious metals markets claimed many ETF investors as well. Among gold-related funds, MarketShares Junior Gold Miners (GDXJ -0.28%) fared the worst, falling 63%. As painful as the drop in gold prices was for commodity investors, mining companies saw even more dramatic declines, as their profit margins got hit proportionately worse. Junior miners were even more vulnerable, with some having to suspend production entirely or keep running at a loss given the big plunge in gold prices. As gold fell below $1,200 briefly this past week, few analysts have anything positive to say about the yellow metal, and miners will continue to struggle until gold recovers.
Even though miners took the biggest hits in precious metals sector, bullion ETFs weren't spared entirely, with iShares Silver Trust (SLV -0.38%) falling 37%. Silver fell even more than gold on a percentage basis in 2013, with investors suffering from the traditionally more-volatile moves in silver prices than for higher-priced gold. One encouraging sign for silver is that ETF investors haven't given up on their holdings the same way that gold-bullion ETF shareholders have, but nevertheless, the outlook for gold and silver in 2014 remains cloudy at best.
One trend that many investors didn't notice was that emerging markets underperformed U.S. stocks severely in 2013. The MarketVectors India Small-Cap (SCIF -0.15%) was one of the hardest-hit ETFs in emerging markets, falling 35% during 2013. Larger Indian companies have performed quite a bit better, with the Sensex benchmark rising to all-time records in the past couple of months. But with big economic problems that include high inflation and slowing growth, smaller stocks haven't attracted the same attention from foreign investors and could continue to lag in the future.
Even outside the precious-metals market, commodities remain sluggish. With the prices of several major crops having fallen sharply in 2013, the PowerShares DB Agriculture Long ETN (NYSEMKT: AGF) fell 33%. Farming has had a huge run in recent years, helping to lift stocks of companies from seed and fertilizer producers to farm-equipment manufacturers. But if crop prices fall, it could create problems that could reverse what has been a major underpinning of the economy's recovery since the financial crisis.
What's next for ETF investors?
These funds might well have been among the worst ETFs of 2013, but that doesn't mean that they're doomed to underperformance forever. Unfortunately, it's hard to guess which ETFs you should avoid in 2014, but at least knowing the trends that sent these ETFs down this year can help you see the impact prevailing conditions can have on ETF prices.
