The Wannabe Middlemen of ETFs - dummies

By Russell Wild

The wannabe middlemen of ETFs are about as necessary as forks in a soup kitchen, but be assured that they will continue to try to muscle in on the money.

Commissioned brokers

Most often they call themselves “financial planners,” and some may actually do some financial planning. Many, however, are merely salesmen in poor disguise, marketing pricey and otherwise inferior investment products and living off the “load.”

The load — or entrance fee — to buying certain investment products, such as some mutual funds, most annuities, and virtually all life insurance products, can be ridiculously high. Thank goodness they don’t exist in the world of ETFs — yet.

When first introduced, the PowerShares lineup of ETFs was designed to be sold through commissioned brokers at 2 percent a pop. The Securities and Exchange Commission killed the idea. But in time, the commissioned brokers will likely return to the world of ETFs, with their lobbyists in tow.

Separately managed accounts (SMAs)

SMAs have traditionally been aimed at the well-to-do. Instead of buying into mutual funds, the wealthy hire a private manager with Persian rugs in his lobby to do essentially what a mutual fund manager does: pick stocks. But now many SMAs are billing themselves as “ETF SMAs.” Instead of picking stocks, they pick ETFs — at a price.

ETF SMAs that promise to beat the market through exceptional ETF selection or market timing are unlikely to do any better than stock SMAs. You should not hold your breath waiting for these guys to make you rich. Some SMA managers may be very good at what they do, but much of what they do is fairly basic.

If you want to hire someone to manage your ETFs, that’s fine, but if they start talking about skimming 2 percent a year off your assets, you’ll do better on your own.

Annuities and life insurance products

A variable annuity company has been running ads about featuring ETFs in its portfolio. Great! That’s better than high-priced mutual funds. But still, most variable annuities are way overpriced, carry nasty penalties for early withdrawal, and prove to be lousy investments. The same is true for many life insurance products other than simple term life.

Investments in ETFs can make these products better, but that’s a relative thing. As a rule, it’s best to keep your investment products apart from your insurance products. And never buy an annuity unless you are absolutely sure you know what you are buying.

Mutual funds of ETFs

The term is “closet index funds,” and there’s an increasing number of them out there, just eager to take your money and invest it in “hand-picked” portfolios of stocks that strangely resemble the entire stock market.

In the old days, closet index fund managers would actually have to wake up on Monday morning to make sure their high-priced portfolios were in line with the indexes. Today, they can sleep late because they’ve socked an indexed ETF or two into their portfolios.

You, the investor, get to invest in the ETF or two, and the alleged manager of the mutual fund gets to milk you for much more than you would be charged as a direct ETF shareholder.

Question the purchase of any mutual fund that features ETFs among its top holdings. Ask yourself if there’s a good reason for you to be paying two layers of management fees. And if those two layers add up to, say, more than a percentage point, you need to really start to question your purchase.

Beware of any mutual fund — such as the Seligman TargETFund Core A (SHVAX) — that charged a 4.75 percent load along with a gross expense ratio of 1.93 percent to hold a bunch of ETFs for you. Although the Seligman fund is dead, others will come to take its place, for sure.