Some time ago, I happened to chit chat with a person who invested into an ETF. The ETF was an IPO and he subscribed to it before the US Fed rate hike. The type of ETF that he invested in is sensitive to Interest Rate fluctuation. Shortly after he bought it, US Fed raised interest rate and that ETF’s price fell.
He was upset because –
- He felt that the IPO should not be issued during the interest rate volatile period. He felt the timing of the IPO was wrong for investors to subscribe. As he subscribed to it, he felt cheated.
- He felt the IPO is poorly managed so the price fell.
As he is a Financial Advisor, and yet he had such incorrect perception, I guess people from general public may also have similar thought which I opine the objective of ETF had been misunderstood.
ETF is passive investing
ETF is a type of collective investment scheme. Its objective is to simulate an index which consists of a basket of different stocks. The Index is designed by third party rather than the asset managers (ETF issuers). ETF fund manager does not try to outperform the index that it is simulating. This is what passive investing about. Poor performance of the ETF is not because of the fund manager’s skills in picking stock. However the falling price, instead, is due to the stocks included in the index are not performing well. The performance of the ETF has nothing to do with the skills of the fund manager.
Index isn’t meant for performance
The objective of an index is to have a meaningful representation of a particular theme/sector. When an Index rises, we can only interpret it as – the listed companies in the index are generally doing well or broad market sentiment is generally good. We certainly can’t claim that the index has picked the right companies and result in good performance.
Timing of ETF IPO isn’t a problem
The objective of IPO of a company and fund are rather different. Company IPO is to raise fund while ETF IPO is to offer investors an alternative way of getting exposure the stocks. However, both in common, their creation is not to ‘make sure’ that Investors make money from the price volatility. The ETF is to allow investors to gain exposure to a basket of stocks conveniently instead of buying many individual companies, so that it is easier for investors to manage their portfolio. Therefore, we should not blame the IPO (be it ETF or a company stock) if the price goes down on the first day of trading. When a stock (of a company) fell, it is due to the supply and demand of the stock itself. However, when an ETF’s price fell, generally it is due to the broad market negative sentiment that causes the majority of the stocks invested in the etf drops rather than the supply and demand for the ETF itself.
Conclusion
Before committing any investment, it is always important to read the prospectus to gain more insight and the characteristic of the investment. Nobody forces us to take money out from our pocket to buy any investment. If we are not comfortable with the investment ideas presented to us, we are always free to decline them.
