What are ETFs: More Risks Investors Fail to Grasp?

Pinnacle Digest writes: There has long been speculation of the underlying risks involved when investing in ETFs. Frank Holmes clarifies a few old and new risks in his most recent commentary.

Billions of dollars have poured into ETFs in recent years and sadly much of this money is partially or fully unaware of the long term risks associated with these types of investments. This cautionary information comes after the Institutional Investor recently highlighted more downside to many of these investments. Its main point is this: Investors need to be cautious of ETFs’ use of hypothetical, back-tested performance.

Like anything, back-tested performance does not always provide a reliable forecast of future performance. Institutional Investor explains that for ETFs to attract assets, some index providers have unique indexes based on various performance characteristics, weighting methodologies and valuation metrics. They then launch an ETF and tout the investment’s theoretical performance - 'theoretical' being the key word.

Holmes cites a recently released study by Vanguard which warns that this may be misleading to investors. Of the indexes that the firm analyzed, 87 percent outperformed the broad U.S. stock market during the time in which back-filled data were used. However, “only 51 percent did so after the index was launched.”

Institutional Investor explains that there may be some selection bias built into the hypothetical results based on what worked in the past. This creates obvious problems and in many cases once these funds were implemented, the real-time performance diverged from historical results. This is something all investors need to aware of and to check closely who is endorsing back-filled data to project future gains.


Read the full article from Institutional Investor HERE


Holmes concludes that, no hypothetical data could replace the historical performance generated by day-to-day, real-time decisions about real assets during bull and bear markets. He paraphrases Warren Buffett, by noting, investors might want to beware of ETFs bearing back-dated results.



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