ETF’s – Are They Performing Better in a Bear Market?

It is notorious that most of the US mutual funds have had to incur losses last year (many of them between -30% and -20%, some of them even lower). And the story got even worse – due to their massive losses, most of these mutual funds were forced to sell big chunks at their assets at a loss and reimburse the capital gains to the investors. Who in turn incurred even more losses because the of the capital gains taxes.
This was very bad for an investor, indeed. And those burned investors started to looking for alternatives. One of them, close in concept, is to invest in ETF’s (exchange traded funds). Unlike mutual funds, ETFs incur zero capital gains until an investor actually sells his shares. While turnover in an ETF’s holdings can be high, it is done through in-kind exchanges of one security for another rather than through selling and buying fractions of the funds assets.
One of the biggest advantages of the ETF’s is their transparency – as an investor, you know in any given day what their portfolio consists of. By comparison, the mutual funds have to disclose their componence only once epr quarter. As such ETF’s allow a much quicker and tailored portforlio management for those investing in.
Another big advantage of the ETF’s is represented by their fees (average 0.25% of the investments value compared to 1-2% in the case of the mutual funds). The lower fees make of course the returns higher with the difference. One of the main reasons why ETF”s fees are so low is because they have a passive trading strategy (they track an index automatically), wherea the mutual funds often pursue an active selection of investments strategy. Of course, a passive investments strategy means, by definition, that their returns can be much lower than those of the active mutual funds (who have a higher risk and thus a higher potential for high returns or big losses).
Last year ETF’s overperformed the market with an average of -12% in return (compared to -37% in the Standard and Poor’s 500 stock index). And as the financial crisis was spreading, investors became more and more risk averse and found a safe heaven in the market-indexed ETF’s, which can be a safer alternative in times of bear markets such as this one.
The ETF’s are very diversified and can have in their components not only shares, but also commodities (such as oil, gold or cereals). Last fall as credit markets froze up, corporate bond prices plunged as very few investors wanted anything to do with individual corporate debt issues. But lots of investors poured money into fixed-income ETFs, seeing lower risk due to the diversification they offered and potential for a bounce in these funds. In essence, the investors are moving their portfolions out of the volatile stocks into diversified indices, which offer less returns but more certainty.