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Why You Should Ignore New ETF Filings

Companies / Exchange Traded Funds Jan 28, 2010 - 03:35 AM GMT

By: Ron_Rowland

Companies

Best Financial Markets Analysis ArticleThe old saying says, “Don’t believe everything you read.” While this is good advice, investors today have a bigger problem: News that is accurate but irrelevant.

I see this all the time as I track the ETF industry. Just about every week — and sometimes several times a week — I receive breathless news like “So-and-so has filed for an ETF to track the price of kangaroo milk in New Guinea!”


Will this be the next ETF?
Will this be the next ETF?

OK, that wasn’t a real story, but I hope you get the point. Sometimes the excitement about unique new ETFs gets out of hand. I’m as happy as anyone to have so many different ways to get involved in different market niches. On the other hand, the news about “filings” is not always very useful. Today I’ll explain why.

How An ETF Is Born

In the U.S., ETFs are regulated by the Securities and Exchange Commission. Every new ETF must be registered with the SEC before it is offered to the public. The process is not automatic, nor is it necessarily quick.

Here’s what happens: Lawyers for the firm that wishes to launch a new ETF prepare a draft prospectus and assorted other materials for the SEC staff to review. This is filed electronically on a computer system called EDGAR.

EDGAR is open to the public. This means that when someone files an application for a new ETF, anybody who wishes can read all about it. Keep in mind, no one can actually buy the new ETF yet, but as soon as the filing hits EDGAR the cat is out of the bag. Specialized research firms will usually pick up the news within minutes and broadcast it to the world.

The financial press likes to report new filings, especially if they are unique and interesting — and sometimes just to fill up space on slow news days. I don’t get too excited when I see these stories. Why not? Here are a few of my reasons …

The SEC is in charge of regulating ETFs.
The SEC is in charge of regulating ETFs.

Reason #1: The mere fact that an application for a new ETF has been filed does not mean it will ever come to market. Why get all excited about something you may never be able to buy?

The fact is, at least recently, most new ETF filings never go anywhere. Just look at last year. As 2009 opened there were 525 “active” filings at the SEC. By the end of the year only 49 had left the launch pad — less than 10%!

By the way, it’s important to remember that the SEC does not “approve” any ETFs or mutual funds. They just “grant registration,” which simply means they don’t see anything illegal in the prospectus. It does not mean they think the ETF will be a good investment. Making that call is your job, not theirs.

Reason #2: You can wait a long, long time before that new ETF you read about is available. The original filing for ProShares ETFs was made in June 2002, but it was another four years before the funds reached the market in 2006!

You can wait a long time before the curtain goes up on a new ETF.
You can wait a long time before the curtain goes up on a new ETF.

Why should you care? Because these delays can tempt you into procrastination. People sit on the sidelines because “something better” is right around the corner. Then when the new ETF finally shows up — if it ever does — they may have missed out on good opportunities in the meantime.

Reason #3: There’s no added benefit to being one of the first to buy a new ETF. It’s not like a stock IPO where early investors can enjoy a first-day surge. ETF price movement is based more on the underlying market than on the number of people who want to buy the particular ETF.

In fact, you can actually hurt yourself by jumping in too soon. How? New funds often take time to attract interest, and in the interim can be highly illiquid. That means extra transaction costs for you. If the new ETF flops, you could have a hard time getting out at a decent price.

Reason #4: An ETF idea that sounds great on paper may turn out to be not so wonderful in real life. A good example is the MacroShares Major Metro Housing bullish (UMM) and bearish (DMM) instruments that came to market with great fanfare last year — only to quietly flop and be delisted in December.

In retrospect, UMM and DMM had fatal flaws from the very beginning. I saw this and avoided them. Unfortunately, some investors didn’t see it coming and found themselves holding the bag.

These are four good reasons I’ve found to ignore ETF filings. Way too many of them turn out to be “vaporware,” to use a term I learned back in my IBM engineer days. They can be fun to anticipate but may never turn into anything you can actually use.

I keep track of all the new ETFs that are actually available. When something new and interesting comes along, I tell my readers. So don’t worry about new ETF filings. I’ll let you know when it’s time to pay attention.

Best wishes,

Ron

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