Economics 104 Homework (assignment 4)

RESEARCHING ETFs

Part 1: Reviewing Traditional Conservative ETFs

Go to the iShares ETF family web site at http://us.ishares.com

Under the ISHARES ETFs tab select "Equity."

On the page that appears, which will list a very large number of ETFs that look like equity mutual funds, peruse the full range of Management Fees and Total Fund Annual Operating Expenses in the columns with those names. W hat are the highest and lowest that you see for all of the funds that you see?

Look at the Total Fund Annual Operating Expenses for their S&P 500 Index Fund (IVV) (toward the bottom of the page). Do you see how low that is?

Now, near the top of the page, select the link for the Dow Jones U.S. Basic Materials Sector Index Fund (IYM) and the information page for that fund will appear. Do the following:

1. Read the fund objective carefully. What does this fund claim to track? Is this a delta fund (that tracks the daily performance of something) or an index fund?

2. On that page you will see a link for a Tracking Error Chart. Select that link and look at the chart. You should know, based upon the reading, what you are looking at and you should know how important it is.

3. Return to the IYM main page. On the page you will see a link for Premium/Discount. Select that link Look at the chart and the data around the chart. Again, based upon the reading, you should know what you are looking at and how important it is.

4. Return to the IYM main page. You can see the top daily holdings. There is a link to view all holdings, so why not take a look? You don't really need to know this but it won't hurt to see where your investment money is going.

On these pages you can also see historical rates of return and the like, which you should review, but historical returns may be less important than the answers to the four questions above. After all, you are treating this as an investment in the future, not the past.

Before you go to the next section, go to http://finance.google.com and in the "Get quotes" box type iym.iv (the symbol followed by .iv). The result that you see is the Intraday NAV of this ETF. Then immediately obtain the price quote for iym. Do you understand what you are comparing? They might be identical but might vary by a few cents.

YOU HAVE JUST SEEN AN EXAMPLE OF AN ETF THAT IS SUITABLE FOR A LONG-TERM INVESTMENT LIKE A MUTUAL FUND.

Before you leave this site, take a look at the variety of funds offered, and go inside a take a look. Look at some overseas funds like the "All Peru." (Remember my warning that on these globals you are facing exchange rate risk and what I like to call "ignorance risk" - what do you really know about Peru' s economy)?

Part 2: Reviewing a Delta Futures-based Commodity Fund

Go to the United States Commodity Funds ETF family web site at http://www.unitedstatescommodityfunds.com

Look at the description of some of the funds. USO and UNG are the best known of these funds. Clearly these are all commodity funds.

Enter the site for the UNG fund. Look at what appears on the page. Do the following:

1. Read the fund objective very carefully, in its entirety. How does this fund differ from the index fund in Part 1? What does it claim to track? Can you see why this is called a delta fund?

2. Bring up the chart that shows Premium/Discount %. This is going to be a lot harder to read than the equivalent chart in Part 1. ( A single basis point is 1% of 1% , so 200 basis points equals 2%). The chart is showing a rather strong positive bias - not fatal or alarming, but bias. With a bias, an error can compound over time, so you should understand why this might now be a suitable investment for tracking the long-term price behavior of natural gas.

3. Under Performance select "quarterly performance" and compare the benchmark (what they are trying to track) to the NAV and to the Unit Price. Since inceptions they are pretty close, which is comforting, but over shorter periods this graph is often skewed.

4. It is hard to find their expense ratio (a bit of a red flag). It is on their "fact sheet" under Literature. W hat is their Total Expense Ratio (the equivalent of Total Fund Annual Operating Expenses for the iShares funds in Part 1). What is it compared to the index funds in Part 1?

5. Now look under Daily Holdings. In what does this fund invest (look carefully at all of it - you should see a combination of futures, swaps, and a rather large holding of cash (if you know what a futures contract is, you may remember that they are effectively leveraged, which explains the high cash component of this portfolio - if you don't understand this, don't worry about it - the point is that this is very different from an index ETF).

6. [Optional]: If an only if you know what a futures contract is, then under Fund Information select the category called "Roll Dates." The need to frequently roll over futures contracts in a market that knows the fund must do this sometimes explains why these funds don't track their objective as well as an index fund.

I personally regard both USO and UNG to be good funds and I trade them and I personally know energy traders who speculate in them and use them for hedging. Having said that,

YOU HAVE JUST SEEN AN EXAMPLE OF AN ETF THAT IS PROBABLY NOT SUITABLE FOR A LONG-TERM INVESTMENT LIKE A MUTUAL FUND.

This homework is not collected.

You may be asked the following question or a similar question on the next exam:

What are the primary differences between an index fund like the iShares Dow Jones U.S. Basic Materials Sector Index Fund (IYM) and a commodity fund like the United States Natural Gas Fund (UNG), and/or why is one of these suitable for a long-term investment like a mutual fund and the other not?