With exchange-traded funds gaining in popularity, a handful of observers are urging caution in marketing them.
Bank brokers in particular should be cautious in selling these products, said an executive, speaking on condition of anonymity, at the fund division of a midsize bank. The reason, he said, is that banks investment customers are generally less sophisticated than other brokerage clients.
Dan Ross, president of Wexel Ross & Partners, a New York financial marketing and design firm, agreed. Bank investors, accustomed to "plain vanilla" products, may not understand traded funds well enough, he said.
Exchange-traded funds are stock portfolios that track an index, such as the S&P 500 or the Russell 1000. Investors face less tax exposure than with actively managed funds, because exchange-traded funds are not constantly trading individual securities and thereby exposing their investors to capital gains taxes.
Shares of exchange-traded funds are more liquid because investors buy and sell them on the open market instead of buying them from and redeeming them with the fund company. They can also be sold at any time of the market day, rather than only at the close.Exchange-traded funds may not be inherently riskier than other investment vehicles, said Bruce Johnston, senior vice president and director of mutual fund sales and marketing at Conseco Funds. However, he said, many have not been in existence long enough to establish a performance record.
What's more, by emphasizing such funds, which are often used for short-term trading, marketers may be undercutting the very argument they have used to encourage investors to buy into mutual funds and stick with them, Mr. Johnston said.
Marketing campaigns hyping the short-term advantages of these funds are "going against all the information we've been telling investors over the past 20 years," Mr. Johnston said.
The fund industry has been successful partially because it has convinced investors that a buy-and-hold strategy with minimal turnover is best over the long haul, he said.
Now, many investors are using these funds as vehicles for short-term speculation on market indexes or in specific sectors, he said. And short-term trading almost always lowers overall returns, he added.
Mr. Johnston coined the phrase "arachno-skepticism" to describe the wariness investors should have about exchange-traded funds. The term refers to Standard & Poor's depositary receipts, or "Spiders," a type of exchange-traded fund on the American Stock Exchange.
Mr. Johnston criticized an advertisement that suggested investors should "collect all" exchange-traded funds.
"How many index funds does one person need?" he asked.
Mr. Ross, however, said there is little risk that the exchange-traded funds would compete for investor dollars with other funds.
"The reality is that they're not mutual fund killers," he said. These funds may ultimately make certain sector funds obsolete, he said, but they pose no threat to actively managed funds.
Exchange-traded funds are merely a "new tool in the broker's tool kit" and can be used to complement other investments in a portfolio, Mr. Ross said.