Latest news, trends and ideas for investing with exchange traded funds | ETF Commentary

When buying index funds that cover smaller slices of the market, watch out for the difference between a fund’s performance and the index that the fund is supposed to track.

The performance-index gap isn’t a problem for ETFs tied to broad-market benchmarks according to Sam Mamudi in the article Not All Index Funds Are Built Alike.  However, exchange traded funds that track more volatile sectors can experience tracking error.

For example, Mamudi points out that the iShares MSCI Emerging Markets Index ETF (EEM) and the Vanguard Emerging Markets ETF (VWO) are both linked to the same benchmark — the MSCI Emerging Markets Index — yet delivered different results in 2009 when the Vanguard fund outperformed the iShares fund.

Turns out that Vanguard has a trading advantage because it pools ETF assets with mutual fund assets.  Another example where Vanguard has an edge – the Vanguard Total Bond Market ETF (BND).

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Investment adviser Steven Goldberg provides his picks for the top exchange traded funds for 2010 on Kiplinger.com.

Goldberg belives that the market will reward shares of the biggest and strongest companies this year and, within that category, the faster growers among them.

Goldberg’s ETF portfolio for 2010 includes:

55% Vanguard Total Stock Market ETF (VTI)

10% Vanguard Mega Cap 300 Growth ETF (MGK)

20% Vanguard Europe Pacific ETF (VEA)

10% Vanguard Emerging Markets Stock ETF (VWO)

5% Vanguard REIT Index ETF (VNQ)

For more diversification, Goldberg recommends adding bonds with funds such as:

SPDR Barclays Aggregate Bond (LAG)

iShares S&P National AMT-Free Municipal Bond (MUB)

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2009 was a good year for Bond ETFs. Through November 2009, taxable-bond ETFs had net inflows of $32 billion, the most among major asset classes according to a recent WSJ article by John Spence.

Broad-based bond ETFs such as iShares Barclays Aggregate Bond Fund (AGG) and the Vanguard Total Bond Market ETF (BND) were popular choices among investors.

Emerging market ETFs were also popular choices in 2009. Two favorites among investors — the Vanguard MSCI Emerging Markets ETF (VWO) and iShares MSCI Emerging Markets Index Fund (EEM).

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While emerging market ETFs have enjoyed large gains since the beginning of March, investors should note that the majority of new money is going into the most liquid funds.

WSJ reporter Kejal Vyas writes in the column Emerging Markets See Spike in ETFs that exchange traded funds for emerging market stocks have seen net inflows of $3.35 billion since the beginning of last month.

Emerging market ETFs favored by investors include the iShares MSCI Emerging Markets Index Fund (EEM) and the Vanguard ETF Emerging Markets (VWO).

Vyas notes that analysts are questioning the sustainability of the rally because ETFs are very liquid enabling investors to make a quick exit if the market sinks again.

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US News New Money columnist Katy Marquardt makes the case for exchange traded funds for investors on a budget in her article ETFs for Beginning Investors.

Marquardt provides three examples of ETFs that she has invested in to gain international exposure for her portfolio.

The ETFs mentioned include Vanguard’s FTSE All-World ex-U.S. ETF (VEU), which specializes in developed countries such as Japan and the United Kingdom. Also mentioned are iShares MSCI EAFE Growth Index Fund (EFG), which buys large, fast-growing foreign companies and Vanguard’s Emerging Markets ETF (VWO).

For more international ETFs, see the special report on Investing in Emerging Markets with Exchange Traded Funds.

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