ETFs may provide diversification, but be wary of exotic types

Exchange-traded funds potentially make it easier for financial advisers to build a well-diversified portfolio that limits volatility by spreading risk. But the proliferation of more exotic ETFs — particularly leveraged and inverse ETFs — could blunt their diversification potential. Because of the ease in which they are traded, ETFs “allow investors to let their emotions get the better of them,” Sam Stovall, chief investment strategist for the equity research unit of Standard & Poor's, said today during a panel discussion at the ETFInsights virtual conference hosted by InvestmentNews. It's a mistake, however, to blame the products themselves, said panelist Roger Nusbaum, chief investment officer of Your Source Financial. “People have been blowing themselves up in the capital markets forever,” he said. While investors can harm themselves using ETFs, they can also do so with any number of other products, Mr. Nusbaum said. Used correctly, ETFs — including leveraged and inverse ETFs — can help reduce risk. For example, Mr. Nussbaum said, he has used inverse ETFs to hedge client portfolios. It helped him avoid the “full brunt” of the stock market's recent decline, he said. But panelist Rudy Aguilera, a founder principal of Helios LLC, an independent registered investment adviser, said he doubts the ability of most investors to time the market with enough accuracy to make leveraged and inverse ETFs useful. Mr. Aguilera, however, said he doesn't have a problem using more traditional ETFs.