Looking Under the ETF Hood

This report examines the structural mechanics and risks associated with Exchange Traded Funds (ETFs), warning investors about implementation pitfalls like slippage, leverage decay, and return-of-capital distributions. It emphasizes that due diligence must go beyond expense ratios to understand how an ETF manages its underlying assets.

Key Takeaways

• 1.ETF suitability evaluation requires examining creation/redemption processes to avoid hidden slippage costs.
• 2.Daily percentage return (leveraged) ETFs contain negative convexity profiles that erode long-term value.
• 3.High distribution yields in ETFs may signal 'return of capital' rather than economic yield, necessitating closer inspection of holdings.

Table of Contents

• Modern Pooled Investing
• Brief History of ETFs
• A Tour of the ETF Sausage Factory
• Passive versus Active Management
• Leverage: Linear versus Daily Percentage Return
• Return of Capital
• Fund of Funds
• Opaque Fees
• Underlying Asset Liquidity
• Strategy Drift
• Summary
• Macro-economic Comments

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