Kauffman Poo-Poos ETFs, Everyone Else Says Their Wrong

First, Happy Veterans Day.

If you follow the ETF industry then you know about the recent report from the Kauffman Foundation that took all sorts of shots at ETFs that were then debunked by IndexUniverse here and here and also by ETF Trends. If you rely on ETFs for any meaningful portion of your portfolio then you need keep tabs on this sort of thing.

You may recall a similar story a couple of months ago when Andrew Bogan wrote an article that got a lot of attention about whether an ETF could implode under the weight of too large a short interest. Like the Kaufmann report many well regarded ETF bloggers quickly pointed out the inaccuracies of that post too.

There is a more useful path for most of us to take here. ETFs are a revolutionary investment product (I may have called them evolutionary before so I guess I am upgrading my opinion). People are right to be on the lookout for potential serious problems and so various folks are exploring the issue and apparently getting some facts wrong as they do but again the ongoing study can be productive.

However ETFs are investment products and every so often investment products go bad one way or another and no one should think ETFs are immune to this possibility. Note that I say possibility because I have no expectation or fear of some sort of fatal flaw that truly destroys the wealth of ETF investors. Just because I have no expectation of such a malfunction does not mean one can't happen. This is extremely, extremely improbable but the idea that it is impossible is incorrect.

Were there to some sort of catastrophe it would not be in every single fund but I would think more like some sort of unpredictable event affecting one of the most frequently traded funds as a sort of one-off. Again, I have no expectation of such a thing.

Obviously I am a big believer in ETFs, use them liberally in my practice and will continue to do so but if your account is large enough where individual stocks mixed in with funds would not create an unreasonable commission drag then you should use some individual stocks.

In the context of building a narrow based portfolio in weighing between an ETF or a common stock, there are plenty of stocks that correlate quite closely with the indexes they are a part; of course this is an easier connection to make with a stock that is a large component of a fund. I made a reference to this the other day noting that Cameco (CCJ) is by far the largest holding in the new Global X Uranium Fund (URA) at about 20% and the stock and fund are very likely to always have a high correlation. The Global X Lithium Fund (LIT) likely has a similar situation with SQM. Anyone interested on both themes could, with proper diligence, could just as easily buy the stock for one of the themes and the fund for the other. Note this is just an example I don't own either stock or either fund personally or for clients.

Additionally I would again bring up the point that ETF don't always pay much in the way of dividends. It is difficult to build a narrow based portfolio with ETFs and get much yield. The point being that no product can meet all needs. However you build your portfolio it seems obvious that for some segments ETFs would be the best way to go but for some other segments individual stocks should be the best way to go. Aside from having a better constructed portfolio you should also avoid the full brunt of some sort of ETF mishap that turns out to be worse than the Flash Crash should it ever happen.

As for the picture, apparently Kauffman is Ewing Kauffman former owner of the Kansas City Royals.