It seems exchange-traded funds have been multiplying like rabbits -- turn your back for a few minutes and more of them pop up behind you. Apparently this pace has been tortoise-slow for some folks. A new proposal by the SEC may clear the way for ETFs to take an even faster path to Wall Street.
Clearing the way
The SEC recently agreed to exempt most ETFs from federal review on their journey to the market. This means that many ETFs could be introduced directly to Wall Street, shaving months or even years of time off the review process. This proposal would also allow mutual funds to invest more heavily in ETFs by eliminating the current 3% maximum holding limit.
I have mixed feelings about this proposal. Generally it's a good idea to get the government out of the review process as much as possible and not to hinder the process of capitalism. After all, the glut of ETFs on the market now is only responding to investor demand.
But even though the move might be smart, I have concerns about how the results could affect investors. The concept of ETFs is a solid one -- trading flexibility, low costs, and tax efficiency are attractive to many investors.
But many ETFs being brought to market are specialized, narrowly focused funds that invest in a very limited segment of the market. Most are too narrow for diversified investors. Many ETFs that will take advantage of this new fast-track will be gimmicky, trendy funds that most people don't need. The market could be flooded with scores of ETFs that might distract investors from what is best for their portfolio.
In the end, investors need to avoid the flashy, limited ETFs and stick to diversified, broad-market funds such as Spiders (AMEX: SPY), PowerShares QQQ (or Cubes) (Nasdaq: QQQQ), or the iShares Russell 2000 Index (NYSE: IWM). This will be difficult, as there will likely be many more ETFs available soon, including the first actively managed ETFs.
So brace yourself for the onslaught of new ETFs, but take care -- most investors should watch from the sidelines instead of rushing in to buy. Slow and steady wins the race!
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