Continuing with the theme of ETFs this week, today I’m going to write about something that doesn’t impact Indian investors yet, but will surely impact them in the years to come.
Currently, the name of the ETFs pretty much lets you know what it means and there’s not much difference between different ETFs of the same category – for example you can look at the performance of any gold ETF over a certain period of time and find that all of them were fairly close in their performance.
This is because their underlying is the same and all of them buy the same gold, and it’s price movement is the same for everyone.
However, this won’t remain the same forever, eventually there will be fund providers who will create a gold ETF that doesn’t actually own physical gold but only replicates its performance by buying Futures contracts, and there may also be gold ETFs that own shares in the companies engaged in gold mining, trading or dealing with jewelery.
For example – I took 4 oil ETFs that trade in the US market, and saw how they performed in the last year.
You will be amazed to see the variance in performance of these funds. While the best performing went up by about 50%, the worst performing went by just 22% or so.
OIH is a fund that invests in oil producing companies whereas USO is the ETF that tries to replicate the performance of oil with Future contracts.
The lesson here is that even though you’d think of both these ETFs as oil ETFs, the performance between them varies a lot, and before buying into any ETF you need to see what they are going to buy, and then keep an eye on how the fund is performing relative to its peers.
The big question here is how to know which fund will perform well without the benefit of hindsight, and apart from looking at a fund and finding consistent patterns I can’t think of anything else. This is probably another case where you can spread your investment between funds of different kinds and diversify a little.