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# Ishares and ETFs: Pushing the DJIA Toward the Cliff

How many of you remember the immortal words of P. T. Barnum? Of Yogi Berra? On Wall Street, the incubation period for new product scams may be measured in years instead of minutes, but the end result is always a lopsided, greed-driven, gold rush toward financial disaster. The dot.com melt down spawned the index mutual funds, and their dismal failure gave life to "enhanced" index funds, a wide variety of speculative hedge funds, and finally, a rapidly growing number of Index ETFs. Deja Vu all over again, with the popular ishare variety of ETF leading the lemmings to the cliffs. How far will we allow Wall Street to move us away from the basic building blocks of investing? Whatever happened to stocks and bonds? The Investment Gods are not happy.
A market or sector index is a statistical measuring device that tracks the movement of price changes in a portfolio of securities that are selected to represent a portion of the overall market. Index ETF creators: a) select a sampling of the market that they expect to be representative of the whole, b) purchase the securities, and then c) issue the ishares, SPDRS, CUBEs, etc. that you can trade on the normal exchanges just like ordinary stocks. Unlike ordinary index funds, ETF shares are not handled directly by the fund, and as a result, they can move either up or down from the value of the securities in the fund, which, in turn, may or may not mirror the movements of the index they were selected to track. Confused? There's more... these things are designed for manipulation!
Unlike managed Closed-End Funds (CEFs), ETF shares can be created or redeemed by market specialists, and Institutional Investors can redeem 50,000 share lots (in kind) if there is a gap between the net-asset-value and the market price of the fund. These activities create demand in order to minimize the gap between the fund net-asset-value and the fund price. Clearly, these arbitrage activities provide profit-making opportunities to the fund sponsors that are not available to the shareholders. Perhaps that is why the fund expenses are so low... and why there are now hundreds of the things to choose from. It is also why a famous 30 stock Market Average has gone up at three times the speed of all the other indicators!
Two other ishare/ETF idiosyncrasies need to be appreciated: a) performance return statistics for index funds typically do not include fund expenses... it should be fairly obvious that an index fund will always under-perform its market, and b) some index funds, ishares in particular, publish P/E numbers that only include the profitable companies in the portfolio. How do you feel about that?
So, in addition to the normal risks associated with investing in general, we add: speculating in narrowly focused sectors, guessing on the prospects of unproven small cap companies, experimenting with securities in single countries, rolling the dice on commodities, and hoping for the eventual success of new technologies. We then call this hodge-podge of speculations a diversified, passively managed, inexpensive approach to 21st Century Asset Management! How this differs from the roots of the dot.com mess is a mystery to me. Once upon a time, there were high yield junk bond funds that the financial community insisted were appropriate investments because of their excellent diversification. Does diversified junk become un-junk? Isn't "Passive Management" as much of an oxymoron as "Variable Annuity"? Whatever happened to the KISS Principle?

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