Motley Fool: ETFs Should Stick to the Basics

Exchange-traded funds (ETFs) should stick to the tactics that made them so successful in the first place, according to MotleyFool columnist and Certified Financial Planner Buz Livingston.

In the beginning, these passively managed, index-tracking baskets offered investors the advantage of low expense ratios, and protection again pitfalls that face mutual funds—such as market timing—because they trade like stocks, rather than just once daily. The Vanguard Total Stock Market ETF, for example, boasted an annual expense ratio of 0.07%, compared to 1.5% for the average mutual fund.

“And then the marketing gurus stormed the gate,” Livingston wrote.

The number of ETFs, and the strategies they employ, has soared.

iShares, the Barclays-sponsored frontrunner, for example, has a menu of more than  100 ETFs, one of which used “tactical rotation,” a phrase more commonly known as “market timing,” Livingston said.

“It’s a way for stock brokers to generate more commissions or actively manage your account, thus justifying their wrap fees,” he wrote.  Low volume trading also leads to pricing problems, he said.

New products like iPath’s Commodity-Tracking Exchange Traded Note and PowerShares Industry Rotation ETF have fees of 0.75% and 0.60%, or 10 times that of ETF pioneers.

Other examples are ETFs that splice indexes different ways, or shift allocations quarterly. 

Already, there are 400 ETFs available to investors, and more are likely to be introduced next year. 

"The industry should follow Vanguard’s lead and offer a limited number of low-cost ETFs,” Livingston wrote.