Today's markets test exchange traded funds

The following edited transcript is from "The Art of Actively Trading ETFs," an InvestmentNews webcast held Oct. 21. Evan Cooper, deputy editor, and Jeff Benjamin, senior editor, moderated the panel. InvestmentNews: Let's start with a question on the minds of many financial advisers. How has recent market volatility affected exchange traded funds? Mr. Lowell: Over the last two months of extraordinary volatility, we saw several ETFs, on both the equity and fixed-income sides of the fence, trading at steep discounts or premiums to their actual net asset value. While none of that really lasted for more than a day or two's worth of trading, it is a clear reminder that this is an industry that's still in its nascent growth phase. That's why advisers and investors alike must pay concerted attention whenever they are making a trade using exchange traded funds, to be sure they understand the price they're paying for a particular ETF. Mr. Lydon: Many of us saw those premiums and discounts. Specifically, there was one ETF, the iShares Lehman Aggregate Fund [offered by Barclays Global Investors of San Francisco] that got to a discount of more than 8% at one point. As Jim points out, that was for a short-term period of time, and it has since corrected to a discount of about 1%. Still, for such an unprecedented market, when liquidity was very tight, I think something like that may have been expected. Overall, I'd have to say that the ETF industry has come through this pretty well so far. Mr. Appel: I agree with Tom. On the whole, our experience using ETFs during this time on the equity side has been very favorable; they've come through this very well. I am very concerned about what happened with bond ETFs, and that would give me pause in the future, although the market does seem to have normalized itself. InvestmentNews: How do each of you use ETFs in your practice? Mr. Appel: There are a couple of strategies we use and which I've written books about. Basically, it's possible to have a very good investment strategy by using traditional buy-and-hold methods or by being more active. Some very nice niches are available with ETFs that are not replicated by available mutual funds. For example, the WisdomTree Emerging Markets High-Yield ETF [offered by WisdomTree Investments Inc. of New York] currently yields more than 8%. This is not a quiet ETF. You have the same risk investing in this as you would in any diversified emerging-markets-type investment. But what's nice is that it gives you excellent sector diversification, because unlike most high-dividend investments, it is not massively overweighted in financials. Only about 20% of the portfolio is financials; the rest is materials, telecom, even technology. If you were looking for an approach that blended high dividends and diversification, you could put 80% of an investment into WisdomTree's U.S. high-yield portfolio and 20% into its emerging-markets high-yield portfolio. That would give you an overall high-dividend portfolio that, based on hypothetical performance against WisdomTree benchmarks over the past 12 years, would have been safer than either approach separately — and still delivered yields in the 7% range. While you still have market volatility, this is an example of something you can do with ETFs that you'd be hard-pressed to do for your clients using mutual funds or individual stocks. There also are possibilities with ETFs that arise because you can trade them as frequently as you want. You could, for example, switch back and forth between different styles depending on which ones are favored by the trend in the market. For example, you could pick an international portfolio and re-evaluate it every three months based on long-term trends. Finally, you could put together a program consisting 20% of real estate investment trusts acquired on a buy-and-hold basis, 30% of foreign-equity ETFs and 50% of U.S. equity ETFs. This would give you a portfolio that is well-diversified, has a very generous return and is certainly ahead of its constituent components. Over the last 20 years or so, the return would have averaged 11.7% a year, had a drawdown of 25% a year and been safer and more profitable than any of its separate components. Obviously, there's no guarantee about what's going to happen in the future. But with ETF strategies, it is possible to combine active and buy-and-hold styles, get a good portfolio, including some niches that are not easily available elsewhere, and keep your clients' costs down, compared to mutual funds' expense ratios. Mr. Lowell: At our firm, we use ETFs together with mutual funds in a combined strategy that basically takes advantage of what Marvin was talking about: using ETFs to help reduce the overall expense of what otherwise would have been just a purely actively managed fund position in any investment category, whether stocks or bonds. We parse the ETF universe into several different model portfolios based largely on investment objectives and timelines, but we also have a purely long/short model portfolio for our members, taking advantage of the extraordinary lineup that [ProShare Advisors LLC of Bethesda, Md.] and Rydex [Investments of Rockville, Md.] provide on the short-selling side and the leveraged side of the marketplace. But we also have a purely quantitative portfolio that draws upon our proprietary-ETF quarterly ranking. Basically, it's a portfolio consisting of the top 10 ETFs out of the total universe ranked and run on a quarterly basis. I'm a great believer in exchange traded funds if used wisely, but I would caution any adviser to check under the hood with as great diligence, perhaps even more diligence, relative to mutual funds or stocks, mainly because now we have three different types of ETFs on the planet. We have what I call traditional ETFs. These are ETFs that benchmark to a known market index that pre-existed the launching of the ETF product. When [Invesco PowerShares Capital Management LLC of Wheaton, Ill.] entered the landscape five years ago, we had the creation of Intellidexes, or basically an index that did not exist prior to the ETFs' existence. And now, of course, we have actively managed ETFs. So you really need to drill down and understand at the very least what the index is that the exchange traded fund is based upon before you purchase it. Mr. Lydon: I agree with all the benefits we've talked about. Obviously, we're all big ETF fans here. But I'd like to share a few ideas that advisers might be able to use today with their clients. We've observed that over the past few years, the average advisory practice has changed its long-term asset allocation strategy to include commodities, currency, global assets and other asset classes. That's been great and will continue to do well in the future. But we saw billions of dollars go into ETFs that in hindsight were quite volatile, and in a buy-hold strategy, there was a lot of pain. As a result, there haven't been a lot of opportunities with growth portfolios so far this decade. A simple strategy that we impose for our management clients is owning ETFs only if they're above their 200-day average. If they drop 8% off their recent high or if they go below their 200-day moving average, we sell. This strategy is very easy to implement and describe to clients. They like having an exit strategy. And frankly, it takes any type of predicting or emotions out of play. Today, however, many ETFs — especially in the growth, global and sector areas — are 20% or 30% below their 200-day moving average. For many clients, we've had cash positions for months, as most of this year, we've been below the 200-day average. So what we're implementing is the opportunity to buy back in when we go above the 50-day average. Actually, some areas have done better than others. So if you've got some cash piled up on the sidelines and clients who are saying, "Gee, is it time to nibble back into the market?" here's a very simple discipline when using a 50-day average that might work in these markets. As an example, regional banks have held up pretty well, compared to the big banks, and one of the regional-bank ETFs is just about to go above its 50-day average. So these are the types of things we're looking for as far as opportunities for our clients. Realize that there is not a lot of tax efficiency in this trading strategy, but tax efficiency hasn't been in the forefront of most investors' minds these days. It's making money and preserving principal. So I hope that helps. InvestmentNews: Tom, how long do you see yourself sticking with the 50-day average? Mr. Lydon: There hasn't been a time since the early '70s when major market indexes got close to 30% below their long-term trend lines. So we're in unprecedented times, and we didn't want to wait to have the market bounce back 20% or 30% before we had an opportunity to get back in. Generally, our idea is that when we go above the 50-day average, we put about 25% back in, wait for a 5% increase in the market, and if that goes up by 5%, we'll put another 25% in. And at that point in time, we'll revert back to the 200-day average, because mathematically, at that point, we'll be back in, because 50-day average numbers are about 10 percentage points less than the 200-day average numbers right now. InvestmentNews: Jim, you mentioned ETFs and short selling. Do you use those ETFs, and can you tell us how they work? Mr. Lowell: We absolutely do use them, and in several ways. With ProShares and Rydex, we've now got a wide enough universe of exchange traded funds that either short or double short, go long or double long, with any given major market, as well as in specific sectors. I felt it was prudent to create — as did many of our members who were clamoring for it — a long-short portfolio that could be used as a compass for investor portfolios. For example, we're long Brazil, from my perspective the strongest Latin American economy, but we're short emerging markets overall. The reason we take that sort of barbell approach is that we're not certain that current problems in emerging markets will persist — any more than we're certain that somehow we won't get remarkably good days. Don't forget, on Sept. 19 emerging markets were up 19% across the board. On Sept. 29, however, they were down 13%. With that kind of volatility, we like to be able to barbell both sides of the equation with a slight tilt either towards bullishness or bearishness. Currently, we're a little bearish, even though it looks as if perhaps the worst days of this subprime crisis are behind us. InvestmentNews: How concerned are you about the events that surrounded, say, the ProShare and Rydex ETFs that shorted financials? Is that something advisers should be concerned about when they are looking at these kinds of ETFs? Mr. Lowell: They certainly need to know that it was a factor, and for nearly two hours on one particular day, you couldn't trade the Pro-Shares short financial services ETF. But by about 11 in the morning, they had been able to basically fix the problem. And that was, of course, exacerbated by the fact that — and I can't blame ProShares for this — there had been an unprecedented intervention by the [Securities and Exchange Commission] and the [Department of the] Treasury that created a do-not-short list among the financial services stocks. So these are, again, signs of what I would say are growing pains within the ETF industry. But the industry itself is so strong and so focused on the fact that it needs to be able to deliver and maintain excellent products to its clientele that all you need to do is double-check, get the answer before you invest and then, once in, not worry. InvestmentNews: Speaking of strengths and liquidity, are ex-change market makers doing their job well? Are there any problems? Mr. Lowell: They're trying to do their jobs as well as they possibly can. But we had a 10% position in the Vanguard Emerging Markets ETF [offered by The Vanguard Group Inc. of Malvern, Pa.] and it took us three days to unwind from that position. We could see some structural weaknesses based on the fact that the specialists weren't able to do their job as seamlessly as possible and that we were a sizable participant in that particular exchange traded fund. So there are wrinkles, but each one comes as a learning experience. Mr. Lydon: Jim, what were some of the problems you faced in trying to unwind the position? Was the spread too big? Mr. Lowell: Exactly. We had to take three steps to minimize the negative impact of that spread. Effectively, we wound up paying about 1.25%, which we'll call a fee, due to that spread. But that was slightly better than what we would have paid if had it been a redemption fee coming out of a mutual fund. Still, we hadn't expected that fee to manifest itself in the way that it did. Mr. Appel: We always have been worried about liquidity, and for that reason, I have a strong bias towards sticking with the more liquid ETFs, although one would have thought that the emerging market ETF would have fit that category. Liquidity can be a problem during a fast market, but we fortunately haven't run into it. We've been reducing our portfolios in a graded manner during the past several months, so we didn't have to move as much as 10% on any one day, and perhaps that's how we were able to sidestep the type of illiquid market that popped up. InvestmentNews: Marvin, you have spoken about looking at sector rotation every three months. Are you making that time frame shorter in light of the market volatility? Mr. Appel: I haven't given thought to making the time frame shorter, because during the current volatility, there's actually a lot of extremely short-term sector rotation from one week to the next. One could attempt to play that in a market-neutral manner with very short-term trades or — what I recommend — by following the long-term trends and expecting that things will work out by the end of a quarter. I think that trying to pick the correct sector or the correct part of the world or the correct style on a short-term basis is fraught with a lot of risk. I also should mention raising cash, which is a very important part of our strategies for clients. We have to do that on a more subjective basis, because we find that a mechanical type of trading system can trigger more trades than we want. We try to reduce the transactions by smoothing out and using a variety of indicators rather than simply one simple powerful type of thing. InvestmentNews: One of our attendees has a question about leveraged ETFs. He wants to know why a leveraged bear fund can be down, say, 1.45%, while the same family's leveraged bull fund goes up just 1.25%. He wonders why they don't move equally in their own direction. Mr. Lydon: On any given day, the funds hold up pretty well, compared to their index. But obviously, there are spreads involved, and over long-term periods of time, if the market goes down 50%, it doesn't necessarily mean that a double-inverse ETF is going to go up 100%. That's just the nature of the composition of the ETF as well as the mathematics of what goes on over time. I should mention too that I'm on the Rydex board, and I have to be careful because the whole construction of these ETFs are, to some degree, proprietary. But it's important to understand that long term, if the market goes down by 50% and you're in a double-inverse ETF, it's not necessarily going to be up more than 100% over that period of time. Mr. Appel: It's been my observation — and this is certainly true on big-move days, — that tracking isn't going to be perfect, and there may be particular problems during big days, or seemingly random problems. I think tracking error is a particular risk on any day when there's a large change in the assets of the ETF, so that the actual costs of liquidating or building new positions becomes significant relative to the change in the value of the portfolio. That has been an issue from time to time. It was an issue we dealt with when we were using Rydex's index in short and leveraged mutual funds, a question of there sometimes being transient slippage between the derivatives used to create an inverse or leveraged portfolio and the price of the underlying securities. Perhaps the two portfolios mentioned were facing different capital flows on a particular day, and that resulted in a different amount of slippage in the ETF. A little bit of tracking deviation from the benchmark is unfortunately one of the risks that you bear in using these ETFs on a short-term basis. On a long-term basis, because the portfolios are re-balanced to achieve their leverage on a day-to-day basis, if the market goes up 50% over the next year, for example, that's not the same thing in a 2-to-1 ETF as if the market goes up 50% in one day. The existence of volatility, or noise, if you will, will degrade the performance of a leveraged or a short ETF through no fault of the index provider. It's simply a function of the mathematics of having to re-balance a portfolio. So even if there was perfect tracking to the benchmark and no expense ratio, the existence of up days followed by down days for zero net movement creates an overall loss in a leveraged or short ETF. InvestmentNews: There are many inverse and leveraged ETFs; what is the best way to evaluate them? Mr. Appel: I look for benchmark tracking and liquidity. If you can evaluate them in a fast market, that's helpful information. If you created an ideal hypothetical inverse [Standard & Poor's 500 stock index] ETF, making allowance for the stated expense ratio, how well does the ETF track the index? That's the way I would evaluate these. InvestmentNews: If an adviser wanted to try some of your suggestions, such as using short and inverse ETFs, what is the best way to start? Mr. Lydon: Over the past year or so, many advisers have begun to use inverse ETFs for the first time. For the most part — and I talk to a lot of advisers — they have been very pleased with the outcome. The products have done what they're supposed to do. There are a lot of advisers who have low-cost-basis stock or fund positions that they wanted to hedge, and they're very pleased that they did. Down the road, as we see more inverse options become available, more market volatility and a wide swing of trends, ETFs will become more of a standard tool for advisers. For many advisers, ETFs are a bit different and still new. Remember, most advisers still rely on mutual funds. For advisers getting into the ETF arena, the experience has been very positive overall. InvestmentNews: Marvin, what advice or suggestions do you give? Mr. Appel: I think for the type of strategies that I've written about and that we've presented, probably the best thing is to start trading on paper. You could get historical data and then calculate 200- and 50-day moving averages and make sure that you have a sense, on paper, of what you would've gotten into and when you would have gotten into it. Then you could see if the results make sense in terms of what's presented. On my website, appelasset.com, for instance, there are historical strategies that advisers can compare to what they would have done. The only other advice is the common-sense suggestion to start small. Start with small orders and see if the ETF behaves the way you expect it to behave — like the benchmark you have in mind or a mutual fund you believe it to be comparable to. That's how I start with any new ETFs I use. I look to see how it's behaved, compared to competing alternatives, if there are any, or how it compared to its benchmark. Then I see how it does in real time, versus the hypothetical history that many index providers will create. I always recommend that people start gradually. Mr. Lydon: There's a question from the audience about custom redemptions that I'd like to answer. Many advisers don't know that you can actually have your custodian work directly with the specialist of an ETF to create customized redemptions or purchases without having to deal with unwinding or building a position. The big supermarkets are very accustomed to doing these types of things. They've got trading desks and great communication with the specialists on the exchanges. So I would hate for redemption issues to inhibit people from thinking about building their ETF allocations, because specialists are there to work with you. And I heard that even during these tough times, they were there and available and getting these types of deals done. InvestmentNews: What size would a trade have to be in order to warrant going to the specialist directly or asking your custodian for special help? Mr. Lydon: I've heard something as little as $3 million. And in Jim's case, obviously, managing that much money and having a 10% position that was a heck of a lot more. So that would've made sense. InvestmentNews: What place do active ETFs have in your strategies? Mr. Lydon: I've been a big proponent of active ETFs. It's nice that they've finally arrived. But since these ETFs are not following a specific index and use some type of black-box approach, we as advisers are going to treat them like we treat actively managed mutual funds. Currently, they're establishing a track record. Most of the ETF providers that are building and producing these actively managed ETFs — and we're going to see a heck of a lot more of them — are planting seeds for the future. These hopefully will provide alpha, with the tax advantages, low costs and tax efficiencies of ETFs. Hopefully, we'll see a greater percentage of actively managed ETFs beat their benchmark than actively managed conventional mutual funds. But I don't think we're going to see big fund flows for another two or three years. Mr. Appel: I would echo what Tom says, in that I would approach actively managed ETFs with caution. My favorite kinds of ETFs, frankly, are those that follow benchmarks that were in existence before they decided to make an ETF out of them. And those also happen to have the lowest expense ratios and many happen to be the most liquid. Since there are many hurdles that providers of actively managed ETFs are going to have to clear in order to compete with their more economical and better-established index alternatives, I'm going to take a wait-and-see attitude. I use mutual funds for my clients too, and I actually think that there's more of a continuum between the pure index fund and a pure index ETF of a sort, like the SPDR that tracks the S&P 500, than there is with ETFs that technically are not actively managed but track proprietary indexes. You really don't know what you're getting with those. I think the leap from there to a true actively managed ETF is relatively small. So I'm going to take a wait-and-see attitude, but ultimately, the proof is in the pudding. We'll see what the performance is and whether they add to available alternatives. I also want to address a few other questions. One attendee asked if I block trade or trade away, and what my experience has been with lower-liquidity ETFs. I have to say that I think our custodians do a good job. We work with Schwab, TD Ameritrade and Morgan Keegan, and we trade online with TD Ameritrade. Often we will block trade the order ourselves, but we will piece it in throughout the day and then do an average cost at the end. At Schwab and Morgan Keegan, we actually have a live trader who works the order for us, and they've done a good job. On the whole, we've had a good experience, but I like to shy away from lower-liquidity ETFs. If it's going to cost you 0.25% or 0.5% to exit a position, you have to be sure that the performance advantage you're getting from that ETF is worth the cost of exiting an illiquid position in a fast market. Based on that, I tend to stay with the more liquid ETFs if I can. Another adviser asked whether the correlation between U.S. and foreign equities is high, and the answer is yes. For that reason, I don't advocate buying and holding a plain-vanilla international-equity portfolio as a permanent source of portfolio diversification, because most market cap outside of the U.S. is in Western Europe, and their market is very highly correlated with ours. In short, combining Western European equities with U.S. equities doesn't give you any real benefit of diversification. Western Europe is great when they're stronger than we are, as they were during most of this decade, but that's not the same thing as risk reduction. So if you're going to diversify using foreign equities, you should use Japan and emerging markets. But understand that when there's a real economic crisis as we've had this year, everything is going to go down together; the benefits of diversification are going to go out the window. Diversification really works best under normal market climates, and you need a type of sell discipline of the sort that [Mr. Lydon] has shared with us as a backup plan if the market climate turns abnormal. InvestmentNews: Tom, an adviser wants to know what happens when you reach your 8% threshold and you sell. What do you do with the money? Mr. Lydon: That's a great question. We actually treat it as a free agent. The great thing is, with ETFs representing so many asset classes, sectors and global regions, there's usually always something that's just going above its trend line. So if you picture cash as a free agent and you wait patiently on the sideline, at one point in time, something is going to pop above its trend line, and we can take a position. There's also a question about our ETF performance report and tool. It's available free at etftrends.com. InvestmentNews: What about exchange traded notes, which are close cousins of ETFs. A lot of advisers are just starting to use these, but recent market volatility has created some problems. Do you use them? Mr. Lydon: ETNs, or exchange traded notes, have a debt component where a bank promises to provide performance of an index in the form of a debt option. They were working very well until this current financial crisis hit us. So anything banking-related came under question. There were a huge number of ETNs in the pipeline, scheduled to be introduced throughout the third and fourth quarter, and those introductions slowed down tremendously. However, as far as I know, these ETNs have done exactly what they're supposed to do. Everybody has held up their end of the bargain so far, which has been very encouraging. Mr. Appel: I agree with Tom. What I like, for example, about the iPath ETNs [offered by Barclays Bank PLC of London] is that the commodity ones track well-established commodity indexes. I consider that a big advantage. But the volume on some of them has been light, and I hope that interest picks up. It'll take a while for people to regain the confidence in the banking system. Currently, I'm using the PowerShares commodity ETFs more than I'm using the iPath ETNs, because that's just one more source of concern that I would have on my clients' behalf that I don't need right now. But they are doing the job and have excellent benchmarks. So I think it's only a matter of time before the credit climate improves and they take off. InvestmentNews: Let's talk about trading volume. What do you consider low ETF trading volume? Mr. Appel: As a rule of thumb, I like my trades to be less than 10% of the typical daily volume. I realize that there are some ETFs that are composed of very liquid stocks, and so that in theory, I could move a lot of volume in the ETF without necessarily running into a liquidity problem as long as the creation and redemption process involves moving liquid stocks. But that's my basic rule of thumb. Mr. Lydon: That's a great rule, Marvin. I think another easy benchmark we use is looking at ETFs that have at least $100 million in assets. There are plenty of good ETFs to choose from there. And frankly, if a new area or a new asset class has ETFs that are starting to populate that area, you'll tend to see assets move pretty quickly. That gives you a little bit more confidence from a liquidity standpoint. InvestmentNews: More than 500 ETFs are now in registration, but ETF launches have slowed. What would you like to see from the ETF industry in terms of new products? Mr. Lydon: It's great to see larger name brands and bigger companies throw their hat in the ring. I think many of us know that [Pacific Investment Management Co. of Newport Beach, Calif.] is now looking at both actively managed ETFs and conventional ETFs. It'll be great to have them part of this new ETF revolution. One other thing that many of us are anxious about is long-term retirement planning for clients. If you look at their individual fund choices within their 401(k) plans and the expenses associated with those, it would be great to see ETFs in some form available within 401(k) plans. [More: Edelman plans ETF based on revolutionary technology] There's a bit of a plumbing issue there regarding the trading and settlement of ETFs, but there are a variety of solutions. There are also some companies out there that are providing 401(k) plan options and ETF options within 401(k)s. But until we see the Fidelitys of the world accept ETFs in 401(k)s, we're really not there yet. And frankly, with the amount of money they're making, with two-thirds of every new dollar coming into Fidelity going in via 401(k) plans, I could understand why they may not be motivated to move in that direction. Mr. Appel: I'm actually very content with the potential products that are already in the pipeline. What I would like to see is better behavior, if I could use that term, among the existing bond ETFs. For example, I think that iShares has two relatively new offerings — the intermediate credit ETF and a shorter-term corporate-credit ETF that are going to fill a great niche for my clients down the road when the corporate-bond market stabilizes. But the kind of volatility breakdown we've noted makes me very leery about utilizing those ETFs. So rather than seeing new ETFs, I'd like to see — and I don't know how to do it — more-diversified bond holdings, or maybe a more liquid bond market that would facilitate the portfolios of these types of ETFs. I think bond ETFs could be a tremendous help to people looking for a low-expense, high-yield type of investment that they can trade in and out of. Otherwise, Vanguard is very competitive with these bond ETFs, but at Vanguard, you might run into trading restrictions. InvestmentNews: When you speak of problems with bond ETFs, what exactly are you talking about? Mr. Appel: The bond market has had a breakdown in liquidity within the past month or so, and there's been a tremendous degree of short-term price volatility that hasn't been matched on a day-to-day basis by the true indexes. On a month-to-month basis, these bond ETFs are doing an excellent job of tracking their benchmarks. But in this fast market, I'm a little worried. We took a position in CIU, which is [iShares'] intermediate-term-corporate-bond ETF, and that trade lost 6% in three weeks. That's the kind of loss you would associate with a high-yield-bond-market fund in a terrible market climate, and here a supposedly safe investment is down by that much. I realize there was exceptional volatility in the corporate-bond market, but I think that was exacerbated by the trading problems or the irregular market behavior on a day-to-day basis in that particular ETF and many others. InvestmentNews: Finally, an adviser asks whether our panelists are making the statement that buy-and-hold no longer works. If that is the case, what is the easiest way to hedge a diversified portfolio? Should an adviser use an inverse ETF index for each long-only asset class? Mr. Lydon: When you look at the last decade, [the idea of] buy and hold has been very, very frustrating for advisers. Today, however, with all the asset classes we have to choose from, there have to be ways to provide alpha. And ETFs give you the tool to do so. So while I'm not a proponent of moving somebody from a buy-and-hold portfolio to a 100%-timing portfolio, advisers can have a normal core portfolio but enhance it by looking at trends as they develop outside that core. That's very easy to do that with exchange traded funds using simple moving averages. In the late '90s, we were 90% in mutual funds. We found that as more assets flew into mutual funds, the best-performing mutual funds closed down or imposed redemption fees, it got very frustrating. Today we're in a whole new situation. ETFs are the best tool that the adviser business could ever hope for. Now it's about finding ways to use the tools and help our clients benefit from them. Mr. Appel: We have used ETFs to hedge mutual funds, and we en-countered one difficulty that advisers should keep in mind: The best mutual funds are not those that hew closely to any one benchmark. So you have to be careful. If you're going to use an ETF to hedge a mutual fund, you must be mindful of volatility and tracking. That's why I have a bias for underhedging. Generally, though, I think the ETF landscape has improved tremendously since I started using them about 10 years ago. It's a lot easier to trade them, and there are lots of good selections. They're an excellent tool for advisers in a market climate where you must be more active in order to protect your clients — the type of bear market we're having this year. EXCHANGE TRADED FUNDS The webcast and slide presentation is archived on investmentnews.com/etfwebcast.