Cramer On ETFs

Jim Cramer had a piece up yesterday on theStreet.com yesterday called ETF Overload. The Abnormal Returns blog also got in on the action.

Some of you may know that I write for RealMoney/theStreet.com, mostly about ETFs. I was asked to participate in a 360 on this topic raised by Cramer. A 360 is where several writers weigh in on a subject.

The following was my response as submitted, I don't know if it will be edited down or not.

In Jim’s recent article titled ETF Overload he questions the utility of some of the new ETFs coming to the market and has some fun with the narrow themes that some of the proposed ETFs cover, like insider buying and under-sponsored stocks.

I too wonder about the merits of the insider buying ETF but the back tested numbers for these things are outstanding. They are really no different than assembling portfolios based on stock screening. Back testing is much different than real life and I feel no need to be the first one into any of them but I would not permanently ignore them either. Some stock screens do work.

A while back I wrote a piece about the IPOX 100 Index Fund (FPX). The theme here, or gimmick if you prefer, is buying IPOs on day seven and holding them until day 1000. As I wrote in the piece, the methodology of picking IPOs is not the thing; the thing is the part of the market it captures. The Index that underlies that fund has been around for several years and has served as a very good proxy (as in it outperforms) small cap growth. Even since its debut this has stood up as FPX has beaten iShares Small Cap Growth (IWO).

This will repeat over and over with the narrower ETFs, they capture what they are meant to capture but could also capture some other effect.

Another thing that I think Jim is missing is that the ETF industry is brand new and evolving. In delivering new, innovative products there will be some very useful funds and some other that just take up space (think the Morningstar ETFs). Hit and miss is inevitable.

One last point, I disagree with Jim on the utility of sector ETFs. On Jim’s shows he is fond is helping his audience with Am I Diversified? The market, as measured by the S&P 500, has 10 sectors. I think Jim would be on board with a stock portfolio that had some exposure to all ten. Not everyone wants to take single stock risk but taking prudent sector risk, as opposed to make big sector bets, can be a different matter.

For example, the financial sector makes up 21% of the S&P 500. An investor wishing to underweight the financial sector could buy one of the broad sector ETFs with 15% of his portfolio and then perhaps one of the insurance ETFs with 2% of the portfolio. This type of process could be done for every sector. There are countless studies and white papers that show sector selection is more important than stock selection and ETF provide this to investors.

I would urge do-it-yourselfers to think outside the lines where ETFs are concerned.