Andrew Allentuck

Monday, January 14, 2002


Exchange Traded Funds
by Jim Wiandt and Will McClatchy
John Wiley & Sons, 2002
284 pages
ISBN 0-471-43484-1

Exchange traded funds made their debut in the early 1990s. Invented to allow investors to put money into pools that replicate major indices, they include SPDRs, called Spyders), that mimic the S&P 500; Diamonds that replice the Dow 30 Industrials, QQQ's, called Qubes, that trade the NASDAQ, and numerous baskets that allow investors to get into foreign markets or to track domestic sectors. In Canada, ETFs include the i60 that tracks large caps on the TSE and even bond funds like i10s that provide a basket of 10 year bonds.

The authors of this admirably instructive book show how to use ETFs to do what mutual funds do but at much lower costs. ETFs, of course, are passive, that is, they are not actively managed. That reduces trading, turnover and taxes. ETFs are priced continuously on their exchanges, unlike mutual funds that are priced only once a day. Most of all, ETFs have very low expenses and fees, as little as a tenth or a twentieth of what some mutual funds charge.

The value of this book is its breadth. The authors deal with issues such as liquidity, weighting of stocks within ETFs and representativeness of certain US sector funds called HOLDRS. They discuss iShares that track such national markets as Belgium, Taiwan, Mexico and Canada.

John Bogle, creator of Vanguard Funds and a grand man of mutual fund investing in the US, said "an ETF is like handing an arsonist a match," a great crack quoted in the book. His meaning - some ETFs have incredible levels of risk. The investor who chases performance by buying an ETF on a hot emerging market after it has had a hot run can watch his fortune burn up in a short time. Efficiency is no substitute for prudence. The prudent investor in exchange traded funds should, indeed must, get this book, absorb it, and then understand what it means to buy indices with no intervening manager to monitor risk.