I hate it when you bite into a piece of chocolate expecting a delicious creamy taste, and instead you get a rush of coconut or orange flavor, leaving a bad taste in your mouth. As Forrest Gump says, ‘Life is like a box of chocolates; you never know what you’re gonna get.’ Same goes for some ETFs. A new report by institutional consultant Casey Research takes a look at the 10 most misleading ETFs on the market.
Some are household names, while others are more exotic and esoteric funds. But what they all have in common is that their names are misleading as to what the fund actually invests in. Senior Analyst Vedran Vuk points out in the report that not all of these funds are bad; some have in fact performed quite well. And just because a fund is not on the list doesn’t mean the fund is straightforward, Vuk says.
As exchange-traded funds (ETFs) became the new craze, companies hastily threw together packages of securities, gave them snazzy names, and sent them out on the market. Few investors closely investigated the holdings or the mechanics – and the fund names made things even more confusing. The old saying, “Don’t judge a book by its cover,” is just as important in the investment world as anywhere else in life.
Here’s the list:
- ProShares Hedge Replication (HDG): This fund doesn’t actually hold any hedge funds. It attempts to replicate the Merrill Lynch Factor Model Exchange Series, using other asset classes to copy the risk and return of the HFRI Fund Weighted Composite Index. It currently holds 82.1 percent in three-month U.S. Treasury bills, Vuk says.
- Market Vectors Junior Gold Miners (GDXJ): Vuk would define junior miners as those with under $500 million in market cap. But this fund’s top 10 holdings are all over $1 billion or more. The top holding, which accounts for 5.23 percent of assets, has a market cap of $2.4 billion.
- The United States Oil Fund (USO): This fund does not follow crude oil prices, Vuk says. “USO’s primary problem is that the fund doesn’t hold physical oil but must maintain positions on the futures markets. And in the futures markets, these funds can lose money when the forward curve for oil prices goes into contango.”
- US Natural Gas Fund (UNG) and other commodity futures funds: UNG has the same contango problems as USO, so it doesn’t track the natural gas prices.
- SPDR Gold Shares (GLD): Yes, this fund does hold physical gold, but Vuk says it’s harder to exchange your shares for actual gold. First, investors need a broker or a market maker to retrieve gold, and it can only be redeemed at a minimum of 100,000 shares. Also, the fund is structured as a grantor trust, meaning investors pay taxes on the underlying assets, and gold is taxed at a higher rate.
- PIMCO Build America Bond Strategy Fund (BABZ): While this fund does invest in Build America bonds, it is concentrated on bonds with long maturities and in troubled states. It includes a 33.9 percent allocation to California, 19 percent to New York, 10.5 percent to Illinois, and 6 percent to New Jersey.
- iShares MSCI Emerging Markets Eastern Europe Index Fund (ESR): While there are a slew of countries in Eastern Europe, the bulk of this fund is invested in Russia, accounting for 76 percent.
- iShares MSCI Pacific ex-Japan (EPP), Vanguard MSCI Pacific ETF (VPL), and PowerShares FTSE RAFI Asia Pacific ex-Japan (PAF): These funds have the same problem as ESR, except with Asia Pacific. EPP holds 65 percent in Australia, while PAF holds 36 percent in South Korea. VPL, meanwhile, holds 62 percent in Japan and another 25 percent in Australia.
- Market Vectors Investment Grade Floating Rate ETF (FLTR): This fund does invest in investment grade floating rate bonds, but the majority of them are financials, with a 91.4 percent allocation to financials.
- Fidelity Dividend Growth Fund (FDGFX): While this fund is a mutual fund, not an ETF, Vuk decided it was so misleading it deserved to be on the list. From the name, you’d expect a good dividend, but this fund yields a mere 0.47 percent dividend. And it’ll cost you 0.93 percent!