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The Spokesman-Review Newspaper
Spokane, Washington  Est. May 19, 1883

Risks accompany ETFs

Meg Richards Associated Press

NEW YORK – With the number of exchange-traded funds rising, more investors are becoming aware of the trading strategies associated with sector ETFs. These baskets of stock can minimize the hazards associated with owning individual equities, allow you to take short positions and make long-term bets. But some experts think sector ETFs are riskier than they appear.

Investors have used actively managed sector funds for many years to target market segments, from technology to energy and utilities, but expenses for such specialty funds have tended to be high. The low cost of indexing, and of ETFs in particular, is part of what makes these newer funds so appealing to institutional and individual investors alike.

You can collect several sector products for a diversified portfolio, or you can buy just one in order to play a theme, said Dan Dolan, director of wealth management strategies for Select Sector SPDRS, which divides the nine sectors of the Standard & Poor’s 500 into ETFs. For investors looking to participate in trends but disinclined to conduct the sort of deep analysis needed to make smart individual stock purchases, sector ETFs are an easy solution, he said.

“I want to be able to sleep at night, and I want stable growth without having a stock blow up in my face,” Dolan said.

“The ETF, the sector ETF, gives you more stability. It does everything an individual stock would do, with more diversification. And if I’m right about the concept, it will perform well.”

Bad news can easily sink a stock, a point underscored recently when dangers associated with painkillers sent shares of Merck & Co. and Pfizer Inc. on a rollercoaster ride. When even blue chips like these are vulnerable, it makes sense to spread out risk with an ETF, Dolan said, particularly when you’re looking to invest in an idea rather than an individual stock.

“If you think the price of oil is going to stay where it is, all of these oil companies will benefit,” Dolan said. “If you believe in the aging demographics in this country, and that more money will be spent on healthcare, being right about an individual stock may not be as important as being right about the concept.”

Unlike traditional mutual funds, ETFs are traded intraday, like stocks, so another way investors might use sector ETFs is to sell them short, said Gus Sauter, chief investment officer of the Vanguard Group, which offers 10 sector funds among the 23 ETFs in its VIPERs series.

For example, suppose you work for Exxon Mobil Corp. and your company stock makes up an uncomfortably large portion of your portfolio; one way to diversify without selling and paying capital gains is to short the whole energy sector.

When you short, you’re betting that the security you’re investing in will fall. In this case, shorting the sector would serve as a hedge against your large stake in company stock. But like all investments, ETFs are best used as part of a broadly diversified, balanced, long-term strategy, Sauter said.

“We don’t think people should place big bets on them,” Sauter said. “So many invest by looking in the rearview mirror. We take a more cautious approach. We do believe there are some advantageous uses of sector ETFs. But people who try to move around, chasing after what did well over the last two or three years – that’s a recipe for getting burned.”