Exchange-traded funds have made it easier than ever for people to invest. But although ordinary investors have gained a lot from their ease of use and low costs, ETFs have caused problems for some industries that took advantage of markets that used to be less penetrable than they are now.
Poor Wall Street!
One industry that's feeling the heat is Wall Street. Many large banks have seen some of their revenue sources dry up because of the alternatives that ETFs give investors. That's especially evident in commodities, where several banks reported steep revenue declines. A report from The Wall Street Journal said that JPMorgan Chase (NYSE: JPM) saw commodity-related revenue drop 43%, while Credit Suisse suffered a 42% drop and Goldman Sachs (NYSE: GS) reported "significantly lower results."
Now, the Journal argued that many major Wall Street commodity players focused on the wrong commodities. Rather than enjoying the record prices in cotton, copper, and gold, most banks have their expertise in oil and natural gas, which didn't have nearly as remarkable a year.
But the rise of commodity-related ETFs almost certainly played a role in the declines. ETFs have made it both easier and cheaper for some investors looking to take positions on commodities on their own, without the help of Wall Street. Rather than opening a commodity futures account and relying on expensive experts to craft an appropriate strategy to follow, you can instead figure out which commodity ETF best matches the exposure you're seeking and then buy it in your regular brokerage account. And though the sophisticated investors who work with Wall Street banks are probably wealthy enough not to worry too much about fees, some are undoubtedly smart enough to use ETFs by themselves, skipping the middleman and getting immediate results.
Miners face competition
In addition to the financial firms that facilitate commodity-related transactions, companies that used to rely on investors to buy their stock as a proxy for the commodities they produce are facing problems from the proliferation of ETFs. With investors now able to invest directly in the types of investments they want, they no longer need to settle for the imperfect substitute of shares of related companies.
Again, commodities provide an excellent example. For years, investors who wanted exposure to the precious metals markets had to deal with a dilemma. To get direct exposure to metals, you either had to trade futures or buy bullion at substantial mark-ups without very much liquidity. But now, investing in gold and silver is as easy as buying the SPDR Gold Trust (NYSE: GLD) and iShares Silver (NYSE: SLV). And the number of commodities available in ETF form has steadily increased over time as investor interest continues to climb.
That may sound like a good thing for everyone. But one gold stock mutual fund manager pointed out recently that with the popularity of precious metals ETFs, mining companies need to work harder to drum up investor interest in order to compete for capital. As Catherine Raw told Bloomberg, "With ETFs you can get essentially pure exposure to gold without any other risks associated with owning a mining company."
In response, miners have made some changes. Rather than issuing new equity to finance a recent deal, Newmont Mining (NYSE: NEM) chose to pay cash for its $2 billion acquisition of Fronteer Gold. In addition, Freeport-McMoRan Copper & Gold (NYSE: FCX) and Goldcorp (NYSE: GG) have dramatically increased their dividends in the past year, as stocks attempt to distinguish themselves from ETFs that only hold physical bullion and therefore pay no dividend.
Look for unintended consequences
On the whole, investors have to be pleased with the results they've gotten from ETFs. But looking for second-order effects can give you unique insight into a trend like the ETF phenomenon. That insight can help you make the most of both ETFs and the collateral damage they're doing within the industries they've touched.
ETFs may be bad for Wall Street, but they can be good for you. Find out about tomorrow's top performing ETFs in The Motley Fool's special free report, "3 ETFs Set to Soar During the Recovery."
