One Often Overlooked Benefit of ETFs: Transparency

by: Index Universe August 26, 2008    
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By Matthew Hougan

One benefit of ETFs that gets passed over too often is transparency.

Our chief technical guru, Fernando Rivera, sent me this story by New York Times personal finance columnist Ron Lieber about a socially responsible mutual fund gone awry. 

According to Lieber, the Securities and Exchange Commission recently fined the Pax World Funds group $500,000 for investing in companies involved in the alcohol, gambling and military industries, in direct violation of the terms of its prospectus. The violations occurred in 2003 and 2004, when two of Pax World's funds bought stocks that violated its screens, including IT companies with significant Pentagon contracts like Analog Devices (ADI) and oil drillers like Anadarko Petroleum (APC).

The Lieber story is cute—good guys gone bad—but it points out a much darker underbelly of the mutual fund industry: You never know what you're getting in an actively managed fund.

Fund companies disclose their holdings to the SEC on a quarterly basis, and alert shareholders to those holdings twice a year. But these reports only offer a snapshot of what a fund is holding, often dressed up at quarter-end to make it look like fund managers were holding all the best stocks all along. It's amazing how the hot stock of the moment appears in almost every portfolio at the end of the year. If all those active funds owned all those good stocks all along, why did they still lose to the index?

The truth is that, between reports, investors have no idea what their funds hold. Often, those holdings are not reflective of what gets reported at the end of the year. Sometimes, fund companies change their whole investing mandates, with active funds piling into value stocks and vice versa.

One of the key reasons financial advisors are gravitating to ETFs is that they offer complete transparency. You can see exactly what stocks a fund is holding on a daily basis.

It matters very little if you specifically look at the fund's holdings; most shareholders, I think, throw their annual reports straight into the recycling bin. The very act of disclosing the contents of a portfolio means that someone will look, and it forces the portfolio company to stay true to its mission.

As the old saying goes, sunshine cleans everything.

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This article has 4 comments:

  •  
    Aug 26 11:16 AM
    Where do I find an ETF's daily disclosures? Is there an SEC link?
    Reply | Link to Comment
  •  
    Aug 26 08:01 PM
    You can find most right here on the internet. Check yahoo
    finance.yahoo.com/ to start.
    Reply | Link to Comment
  •  
    Aug 26 08:54 PM
    Hi User112599,

    I went to XLE's holdings on Yahoo finance and it only listed the top tenholdings as of June 30.

    Any other suggestions anyone? How about you, Matthew. Where do I get this info?

    Thanks.
    Reply | Link to Comment
  •  
    Aug 27 10:41 AM
    For a list of the complete holdings of an ETF, go to the issuers web site.
    Reply | Link to Comment
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