Rule changes will open the floodgates to new ETFs. There's going to be a raft of new exchange-traded funds (EFTs) opening the rest of this...

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Rule changes will open the floodgates to new ETFs.

There’s going to be a raft of new exchange-traded funds (EFTs) opening the rest of this year, but chances are investors should ignore most of the new issues. The expected creation of hundreds of new funds is the logical outcome of two rule proposals and one rule change, approved recently by the Securities and Exchange Commission.

If passed, as expected, after a comment period, the rules will streamline the approval process for ETFs, turning something that was tedious, time-consuming and difficult into a walk in the park. Fund firms will be taking that walk with abandon, leading to every kind of new issue marketing minds think will sell.

The changing landscape will go a long way to increase the market share that exchange-traded funds have already captured, but it won’t necessarily lead to a lot of satisfied customers.

“The SEC, in some ways, is giving up its role as a gatekeeper here, which means that individual investors will have to step up their due diligence and think about the best long-term solution for their portfolios,” says Sonya Morris, editor of the Morningstar ETF Investor newsletter. “Those solutions probably won’t come from the new funds. … With those, I think investors have to remember that it’s ‘buyer beware.’ “

Exchange-traded funds are an increasingly popular alternative to traditional mutual funds. Functionally, they are index funds that trade like stocks, so they can be bought or sold by a broker on a moment’s notice, rather than having all transactions held up until they can be made at the day’s closing price.

Typically, ETFs have an edge over traditional mutual fund in costs and tax efficiency, although some of the new flavors of funds being created operate in a fashion that negates the natural edge of the ETF structure.

With more than 600 ETFs on the market already, the field is crowded; yet most observers expect the new rule to result in a doubling of the number of ETFs within a year. Dave Fry, editor of ETF Digest, says new ETFs can fill voids in a few areas of the market, but most new issues will be repetitive, or worse.

“There is no reason for an individual investor to be a pioneer in a new ETF,” Fry says. “They should look at where the liquidity is and at how much money the ETF has under management as part of their decision.”

That’s because some recent new ETFs failed to draw significant inflows and wound up closing quickly, giving investors their money back. At the end of last month, the Claymore funds closed 11 young issues, ranging from the Index IQ Small Cap Value fund to the Clear Global Vaccine Index, to the Zacks Growth & Income fund.

Says Jim Lowell, editor of the Forbes ETF Advisor newsletter:

“Kick the tires hard. There will be shelves lined with investment products that sound good but are untested in the real world. If you think those new funds will be the cure for your portfolio, good luck.”

Chuck Jaffe is senior columnist at MarketWatch. He can be reached at cjaffe@marketwatch.com or Box 70, Cohasset, MA 02025-0070.