Five ETF Targets to Consider Selling Now

In my Money and Markets columns I usually tell you about opportunities I see in exchange-traded funds (ETFs) and how you can grab them.

Today I want to do something a little different: List some ETFs I think you should absolutely NOT buy!

In fact, if you own any of the ETFs mentioned below, you should probably consider selling them as soon as possible. As you’ll see, your money could be much better off elsewhere.

Sell Target #1:
Long-Term Bond ETFs

I’m a big fan of bond ETFs. And I’m glad investors can now get access to different parts of the fixed-income markets in ETF format.

Even so, not every bond ETF is a good bet all the time. And I think now is a bad time to own long-term, Treasury bond ETFs. Martin and Mike have done an excellent job explaining why in their weekly columns, and I’m in full agreement with them.

One ETF in this category is especially dangerous during the current environment: Vanguard Extended Duration Treasury (EDV).

EDV specializes in long-term U.S. Treasury bonds, 20-30 years. And as you probably know, bonds with long duration/maturity are more sensitive to changes in interest rates.

This means that for every 1 percent rise in long-term interest rates, EDV could lose 20 percent of principal. So you should consider getting ahead of the crowd and selling EDV now.

Sell Target #2:
High-Expense ETFs

Running an ETF isn’t cheap. Hence, every ETF has some level of built-in operating expenses. No surprises there — the sponsors are in it to make money.

ETF sponsors also compete against each other. Therefore when someone else offers a more-or-less equivalent ETF with lower ongoing costs, you might want to take a serious look at the cheaper alternative.

Smart sellers lure customers with bargains.

For instance, suppose you want a U.S. “total market” ETF — one that covers the whole domestic equity market. iShares S&P 1500 (ISI) might be a logical choice. It seeks to capture the spectrum of large-cap, mid-cap, and small-cap stocks.

ISI isn’t a bad fund. But Vanguard Total Stock Market (VTI) is just as good and has an annual expense ratio of just 0.09 percent — less than half the ISI expense ratio of 0.20 percent. VTI also holds more than twice as many stocks: Around 3,400 vs. only 1,500 in ISI.

If you want to own a fund of this type, VTI could make a lot more sense than ISI.

Sell Target #3:
ETNs with ETF Alternatives

Every time I mention exchange-traded notes (ETNs), I refer you back to the article I wrote last year about their unique risks. You might want to click here and refresh your memory, because everything I said back then still applies today.

Some ETNs are worthwhile because they offer access to markets you can’t buy otherwise — or at least not easily. But when you have a choice between an ETN and an ETF, you can eliminate “counterparty risk” by going with the ETF.

Here’s a good example: If you think platinum prices are going up, you might be considering iPath DJ-UBS Platinum ETN (PGM) or E-TRACS CMCI Platinum TR ETN (PTM). Both are exchange-traded notes that leave you exposed in the event the issuer runs into trouble.

PPLT is a better way to trade platinum.

You can accomplish almost the same thing through ETFS Physical Platinum Shares (PPLT) without worrying about counterparty risk. PPLT is legally a stand-alone entity that doesn’t depend on the issuer’s credit rating.

PPLT delivers the same platinum exposure as PGM or PTM, without the unique risks of being an ETN. In fact, it seems to track the spot platinum price even better than either of the platinum-based ETNs. So if you like platinum, consider avoiding PGM and PTM and going with PPLT instead.

Sell Target #4:
Illiquid, Low-Volume ETFs

With hundreds of ETFs and ETNs now covering many different market segments, it’s no wonder there is some overlap. New players have rushed to launch dozens of me-too funds. But there’s no way they can all survive. And I think a big shake-out is coming.

Which ETFs will drop out of the race first? The truth is they’re already going fast. Just in calendar year 2009, some 56 ETFs and ETNs were closed and delisted. I expect as many, and maybe more, to bite the dust this year.

There’s no need to panic if you own an ETF that closes down. The sponsor will simply liquidate your shares and send you a check — but you’re much better off not having to deal with such a headache in the first place.

I have an early-warning system that I call “ETF Deathwatch.” I simply rank funds based on their average daily dollar volume. Those that can’t manage to trade even the small amount of $100,000 daily after an initial shakedown period are probably doomed. Some go days or weeks with no volume at all.

Don’t buy them, and consider selling if you own any such funds.

As of last month I had 99 ETFs and ETNs on my Deathwatch. The top five (or the five least-active ETFs) were:

Elements Ben Graham Large Cap Value ETN (BVL)
E-TRACS CMCI Livestock Total Return ETN (UBC)
Elements Spectrum Large Cap US Sector Momentum ETN (EEH)
E-TRACS CMCI Short Platinum Excess Return ETN (PTD)
Barclays Asian & Gulf Currency Revaluation ETN (PGD)

You’ll notice all five are ETNs — another reason these hybrid securities deserve extra scrutiny. You can view the full Deathwatch list by clicking here.

Sell Target #5:
Unexpectedly Risky ETFs

All ETFs have risk. There are no guarantees. I think most investors understand this.

At the same time, we should expect ETFs to at least meet their objectives, broadly speaking. If a fund is supposed to have a below-normal risk profile, we should ask some questions when it doesn’t.

Investors should always know what to expect.

Dividend ETFs, for example, were all the rage a couple of years ago when the stock market was topping out. Conservative investors were enticed into funds like First Trust Morningstar Dividend Leaders (FDL) in the hope steady dividends would balance out market volatility.

Unfortunately, FDL plunged more than 65 percent in the recent bear market, even including dividends — not at all what most investors had anticipated. Since other ETFs with similar objectives performed much better, the FDL methodology is obviously flawed in some way. It’s lightly traded and illiquid to boot.

If you own FDL at a loss, now is probably a good time to take the hit and switch into a better alternative. Vanguard Dividend Appreciation (VIG) is worth a look.

Seasoned investors know that the “sell” decision is just as important as the decision to buy. Today I hope I’ve given you some food for thought about your ETF choices. Consider using it to review your portfolio and see if you can improve your results.

Best wishes,

Ron

P.S. Weiss Research has teamed up with the Red Cross to help gather donations for Haiti disaster relief. If you’d like to contribute, click here now.

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