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The August 2017 AAII Journal is Now Available Online

 

Feature Article: Exchange Traded Funds »

The Individual Investor’s Guide to Exchange-Traded Funds 2017

Detailed return information and data on more than 500 exchange-traded products, including an overview of the ETF industry.


Exchange-Traded Funds »

The Four Groups of ETFs

Viewing ETFs as being vanilla, active, strategic or idiosyncratic makes it easier to understand their strategies and how they differ.


AAII Model Portfolios »

Model Fund Portfolio: Two ETFs Replaced With Lower-Cost Equivalents

by James B. Cloonan

The new mid-cap and small-cap ETFs have both lower expense ratios and lower trading costs than the funds they are replacing.


Departments

Briefly Noted

Current news items of interest to individual investors.

Letters

Members comment on former hedge fund manager Walter Weil’s contrarian approach and value investor Paul Merriman’s blended approach. Plus, member thoughts about Roth IRA rollovers and the effectiveness of using the accrual ratio to judge earnings.


Editor’s Note

In last year’s exchange-traded fund (ETF) guide, we discussed reduction in fees announced by several ETF providers. Price competition continues, though the fee cuts are not universal.

The median fee for U.S.-listed ETFs was 0.50% as of June 30, 2017. This is unchanged from a year ago. The average fee has come down slightly: 0.56% now versus 0.57% a year ago. Since the median shows that the proportion of funds with fees above and below 50 basis points (a basis point equals one-hundredth of a percentage point) has not changed, intuition tells us that the fee compression is occurring at the cheap end of the scale.

One sign of fee compression is the number of ETFs with expense ratios below 0.10%. Last year, 59 funds had single-basis-point expense ratios. This year, there are 79 such funds. At the very bottom of the expense spectrum, 17 ETFs now charge five basis points (0.05%) or less versus just eight in June 2016. The fund companies offering such bargains are iShares, Vanguard and Schwab. The Credit Suisse FI Enhanced Europe50 ETN (FIEU) also has a five-basis-point expense ratio, though the company cautions in a footnote that the realized expense ratio could be higher on an annual basis due to compounding.

Fund families are able to cut fees because of scale. Wall Street loves charging based on assets under management (AUM) because as the dollar value of assets rises so does the absolute amount of fees realized. Thus while “we’ll make it up in volume” may be an old joke about retailers selling goods at too low of a price, it actually does work for investment managers up to a certain point because of scale.

Vanguard and iShares show how much scale matters. Nearly $1 out of every $4 in U.S.-listed ETFs (24.7%) is invested in a Vanguard exchange-traded fund. An attraction for the $735 billion of assets placed with the fund giant are the fees; Vanguard’s ETFs have a median expense ratio of just 0.10%. Even bigger than Vanguard is BlackRock’s iShares, which boasts an ETF AUM of $1.17 trillion (39.4% of all U.S. listed ETF assets). The median fee for iShares is higher, but still low on an absolute level at 0.39%. A big difference between the two companies is the number of offerings: Vanguard has 70 ETFs, whereas iShares has 337 ETFs. (These numbers are current as of June 30, 2017.)

The downward pressure on fees is not just limited to ETFs tracking the traditional indexes. In June, Guggenheim announced a 50% fee reduction in its S&P 500 Equal Weight ETF (RSP) to 0.20%. This is a win for those of you following the Level3 Passive Portfolio and/or our Model Fund Portfolio. Earlier this year, the major online brokers lowered their commissions on ETFs—and stocks—to a range of $4.95 to $6.95 per trade. Add in commission-free ETF offerings and it all means more money in investors’ pockets.

Cost, though very important, should not be the only factor driving your investment decisions. The investment must fit into your long-term strategy. If it doesn’t, a low expense ratio is meaningless.

To pick the right ETF, look at the index the ETF is designed to follow. Even similar-sounding fund and index names can have very different portfolios. This is particularly the case with funds designed to track certain sectors and/or that use quantitative strategies like the so-called smart beta and factor funds. If you don’t fully understand the ETF’s strategy or the strategy of its underlying index, don’t invest in the fund.

Finally, and most importantly, avoid the funds designed to take advantage of the current fads. Every year, we see new funds based on specific themes. This year’s expanded online guide includes new entrants The WEAR ETF (WEAR), Spirited Funds/ETFMG Whiskey&Spirits ETF (WSKY) and The 3D Printing ETF (PRNT). They invest in wearable technology, whiskey and 3D printing companies, respectively. I have yet to see an asset allocation model that calls for direct exposure to any of these niches.

c

Charles Rotblut, CFA
Editor, AAII Journal
@CharlesRAAII

 

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