For investors seeking easy ways to invest in a wide range of markets, exchange-traded funds have never been hotter. But after years of market-moving innovations from ETFs and despite record numbers of new funds, 2010 was relatively disappointing in terms of asset collection for new ETFs -- suggesting that we may already have seen the beginning of the end of the hyper-growth phase for the hot investment vehicle.
Up-and-comers
ETFs have already come a long way. Topping the $1 trillion mark in assets, ETFs are available for nearly any asset class you can think of and probably more than a few that you've never considered before. Their combination of easy access via U.S. exchanges and usually reasonable management fees are giving traditional mutual funds a run for their money.
It was inevitable, though, that ETF managers would eventually grab all the low-hanging fruit, leaving new ETFs scurrying for an ever-decreasing pool of available assets. In 2010, more than 200 new ETFs came to market. But among those, according to the Financial Times, only 17 managed to reach the $100 million mark in assets under management. That's seen as a break-even point for profitability, because a typical expense ratio around 0.50% would bring in $500,000 in annual revenue for a $100 million ETF -- hardly enough to pay for a modest staff and other expenses.
Some of those 17, most notably the Vanguard S&P 500 (NYSE: VOO), only filled in ETF gaps in already extensive product lines. But several others are worth a closer look. But you have to ask yourself: Do these successful ETFs deserve a place in your portfolio?
The other white metal(s)
Last year, everyone was talking about silver. Silver ETF ProShares Ultra Silver (NYSE: AGQ) was the top-performing ETF of the year, and the white metal surpassed gold's moves to new records.
But two of the most successful ETF offerings in 2010 featured less well-known precious metals. The ETFS Physical Platinum Shares (NYSE: PPLT) and ETFS Physical Palladium Shares (NYSE: PALL) both hit pay dirt, each gathering around $600 million in assets last year. Palladium, which is a key component in auto manufacturing, actually outperformed silver bullion, nearly doubling last year.
Whether they'll stay popular depends largely on how long the bull markets in precious metals last. As long as prices don't plummet quickly, however, these ETFs should continue to attract attention.
Emerging ETFs
Emerging markets have been hot. But one criticism of typical emerging-market ETFs is that they invest primarily in easily accessible industries like banking and energy, leaving the true engine of economic growth -- consumer demand -- out of their portfolios.
That's the motivation behind EGShares Emerging Markets Consumer ETF (NYSE: ECON). It helps round out emerging-market portfolios by giving exposure to technology and consumer discretionary sector stocks. Whether local economic activity expands more quickly than global trade for emerging markets remains to be seen, but if it does, then consumer stocks -- and ETFs like this one -- should do well.
Gimme some money
Income investors are pushing for yield, and two bond ETFs reflect that need. One, the PowerShares Fundamental High Yield Corporate Bond (NYSE: PHB), wasn't new in 2010, but it makes this list because it changed gears last year to put together a junk bond portfolio that's weighted by fundamental factors like dividends and cash flow. That makes it arguably safer than other bond funds whose weightings are determined by total issuance -- thereby potentially owning more bonds of those companies that are deepest in debt.
Similarly, WisdomTree Emerging Markets Local Debt (NYSE: ELD) seeks to cash in on interest in emerging markets. With greater economic activity, inflation concerns in China have pushed interest rates higher, offering investors greater returns in local currency terms. Moreover, since the U.S. dollar has been relatively weak against emerging market Brazil, which floats its currency, you've gotten an additional boost by holding foreign bonds. Again, a reversal of fortune in the currency markets could turn this ETF from boom to bust in a hurry, but at least for now, the fiscal situation in the U.S. supports stronger international debt investments for the foreseeable future.
Don't give up
Even with relatively few ETFs making the $100 million cut, that doesn't mean that ETFs are doomed to eventual failure. One analyst has already pointed out that the numbers aren't that much different from past years, and that ETFs often take a while to be successful.
What is clear, though, is that you already have plenty of great choices in the ETF universe. If 2011 brings a better product, it's really just icing on the cake for investors.
