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The many virtues of ETFs

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Using exchange-traded funds – tradeable baskets of stocks – is an efficient way of getting exposure to various investment styles, says Morgan Stanley Dean Witter in a report.
There are now 16 style index-linked ETFs which trade throughout the day on the American Stock Exchange, it says. These include iShares, focused on either growth or value on the S&P500, S&P400 and S&P600, growth and value iShares based on the Russell 1000, Russell 2000 and Russell 3000, and streetTRACKS DJ Large Cap and streetTRACKS DJ Small Cap – each also in both styles.
“They are well diversified, which reduces company-specific risk associated with individual stocks,” say the report’s authors. “In addition they have lower expense ratios, greater tax efficiency and provide more trading flexibility than open-end mutual funds,” they say.
Investors should have exposure to both growth and value, MSDW says. These two styles have historically outperformed at different times in the economic cycle, and holding a mixture of growth and value ETFs should ensure reasonable performance in both types of environment. It may reduce overall volatility, it says.
However, investors can also use style-based ETFs to enhance returns by rotating between styles, says MSDW. “Investors can easily overweight or underweight their portfolio with ETFs to become more growth or value oriented,” it says. Three strategists at the US securities house currently favour value stocks, the report says.

l Index-linked ETFs can also be attractive investment intruments for tax planning purposes, MSDW says.
Using a basket of sector ETFs, an investor looking for broad market exposure can create returns which resemble a major market index, the securities house says. However, a basket strategy can be either market neutral or weighted towards certain sectors.
Because this strategy disperses returns, it should create gains or losses in individual sector ETFs. At the end of the year, these gains or losses can be realised by selling some of the ETFs to offset a tax position in other parts of the portfolio, MSDW points out in its strategy note.
Apart from this, investors using an ETF sector strategy can harvest gains or losses throughout the year as sectors perform in different directions, rather than waiting until the fourth quarter, it says.

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