by Kyle Woodley | March 7, 2012 10:47 am
Exchange-traded funds offer plenty to investors. The ability to buy and sell a bundle of stocks with just one trade makes it easier to balance your portfolio, play entire industries or even track the whole stock market.
Of course, some perks come with a price: the oft-overlooked expense ratio. Just like mutual funds, an ETF’s expense ratio is what you’re paying a company to put together this convenient trading vehicle. The cost is baked into the fund’s returns, and the money goes toward paying the manager if it’s an actively managed fund, marketing materials, keeping the company’s lights on, you name it.
Some funds are pretty simple, and the price reflects it. For instance, Vanguard S&P 500 ETF (NYSE:VOO) lets investors simply track the S&P 500 for a thrifty 0.06% expense ratio. If the market goes up, VOO goes up. Nice and simple.
But if you want to make some more creative plays, you’ll have to pay. A number of funds let you double or triple your returns, put fund managers to work selectively shorting stocks or even let you trade fear itself — but they’re also among the highest-priced funds out there. Here’s a look at the seven priciest expensive exchange-traded funds (as listed by etfdb.com):
One thing that can bulk up a fund’s price tag is leveraging. It’s one thing for a fund to just buy a few stocks and hold them. It’s another to try to finagle a return of three times the inverse of an index — without holding anything.
Four VelocityShares funds do just that — for a hefty 1.65% charge:
The “ETN” designation is important to note. Unlike an exchange-traded fund, exchange-traded notes don’t actually hold a basket of equities. Instead, they use kinky derivatives to tie their performance to various indices, tracking things like bonds or commodities. In this case, DSLV and USLV are tethered to silver futures — unlike the iShares Silver Trust (NYSE:SLV), which simply holds physical silver. DGAZ and UGAZ move based on natural gas futures.
While the headline number is high, the expense ratio for these funds isn’t much of an issue. Funds that offer multiplied returns typically are used to make short-term bets in hopes of big payoffs. What investors should keep in mind, however, is that these bets have massive downside potential. If you’re wrong with USLV, you’re triply wrong. So, before trading for any 2x or 3x fund, determine what kind of losses you can cover, and set an appropriate stop-loss.
Speaking of trading intangibles — should the mood strike, you can even trade fear.
The Chicago Board Options Exchange Market Volatility Index (or, more commonly, the VIX), gauges the expectation of expected future stock market volatility — any movement, good or bad — by weighing options prices on the S&P 500. And because investors traditionally hate volatility, it picked up the “fear index” moniker.
In short, when news gets investors to fret — think eurozone debt or a Chinese slowdown — you can bet the VIX is climbing.
Click to Enlarge VelocityShares has a pair of funds that not only allow you to play the VIX, but double down on it — the Daily 2x VIX Short-Term ETN (NYSE:TVIX) and Daily 2x VIX Medium-Term ETN (NYSE:TVIZ), also costing 1.65%. Like the names imply, they are tied to short-term (one-month average) and mid-term (five-month average) options and essentially are bets on how crazy you think the market will be. As you can see in the chart, these funds gained strongly during the volatile fall of 2011, but have tapered off significantly during the market’s reasonably smooth rally in 2012.
Again, you’re getting what you pay for — 1.65% is about as costly as it gets, but you’re buying the right to make leveraged bets on fear.
The AdvisorShares Active Bear ETF (NYSE:HDGE) is, as the name implies, an actively managed ETF that makes its money by shorting stocks. It’s also the priciest ETF on the market, at a 1.85% expense ratio. For that pound of flesh, management will pore through the markets, seeking out companies that have weak earnings, accounting problems or other red flags, then bet against the house.
Click to Enlarge But unlike the previously mentioned funds, this expense ratio is hard to justify. Because HDGE is actively managed, it’s not tethered to any index. But a look at this chart shows HDGE more or less acts to the inverse of the S&P 500 — and if you simply want to bet against the market, there’s a number of cheaper avenues to pursue.
For instance, the ProShares Short S&P 500 (NYSE:SH), which makes its money when the S&P 500 dives, comes at half the price, with a 0.9% expense ratio. The ProShares Short Dow 30 (NYSE:DOG) works similarly, but with the Dow, at 0.95%. Since HDGE’s inception early last year, all three have been losers — but HDGE, down 18%, cost the most and lost the most.
Kyle Woodley is the assistant editor of InvestorPlace.com. As of this writing, he did not hold a position in any of the aforementioned securities. Follow him on Twitter at @KyleWoodley.
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