In this week's Barron's cover story, Jonathan Laing explores some of the hidden risks of exchange-traded funds, or ETFs.
ETFs are securities that trade on an exchange, like a stock, and are designed to track the performance of a certain index or sector of the market. One of the most popular ETFs, for example, is the SPDR S&P 500 ETF, which trades under the ticker symbol 'SPY' and seeks to track the performance of the S&P 500.
A primary concern Laing addresses is how ETFs will act during a market downturn, writing that: "For all their popularity and éclat, exchange-traded funds are like blockbuster drugs — hugely beneficial when used correctly, but not bereft of potential adverse side effects."
Laing cites Rick Ferri, who uses ETFs in his money management business and has written extensively about these instruments, who said ETFs "performed admirably" during the financial crisis. He added, however, that the industry is now three times larger.
Ferri said that ETFs now cover "so many more illiquid asset classes that investors could suffer adverse consequences in the next major market down that we don't know of yet."
And as the industry has grown, ETFs risk becoming more important the indexes they represent.
[Mark Wiedman, head of BlackRock's iShares] really turned heads when he asserted in a June 29, 2013, letter to iShares fund-holders that 'more and more, ETFs — rather than the underlying indexes that are supposed to drive them — 'are becoming the true market.' In other words, if investor fears cause the market for bonds or some other asset effectively to freeze up, ETFs may well be the only thing left trading. In such cases, the ETF in a very real sense 'becomes' the market. Is that desirable, or even advisable? Probably not: That 'cure' is worse than the disease.
To avoid the financial peril that can come with getting stuck in a ETF vulnerable to large market swings, Laing writes that investors should stick to ETFs "representing broad, liquid parts of the market and offered by reputable companies."
EMC Shares Have Upside
Also in Barron's this week, Lawrence Strauss takes a look at data-storage company EMC, which has seen shares underperform in recent years, though the stock has recently come to life.
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Strauss notes that Elliott Management, the hedge fund led by Paul Singer, has taken a 2% stake in EMC and is urging the company to spin off data-center software company VMware.
EMC owns 80% of VMware, which is now almost as large as EMC with a market cap of $43 billion compared with EMC's $60 billion, Strauss writes.
"Even if VMware isn't spun off — and there's a good chance that it won't be, at least in the short term — EMC should do fine with its federation structure, though it could take longer for the stock to move," Strauss writes. "So, regardless of what course EMC chooses, its stock should come out from under the cloud that's been hovering over it."
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