Comparing ETFs? Don’t Just Look At Expense Ratios

The rule when buying ETFs is that when all things are equal, buy the one with the lowest expense ratio. But remember that similar sounding ETFs often aren’t equal. This means don’t let the expense ratio be the only factor in choosing an ETF.

“Our belief is expenses and past performance matter, but more important is understanding what’s inside the portfolio,” said Todd Rosenbluth, S&P Capital IQ director of ETF research.

SPDR S&P 500 ETF (SPY) tracks the S&P 500 stock index and charges a tiny expense ratio of 0.09%, commonly called nine basis points. One hundred basis points make up 1 percentage point. Guggenheim S&P 500 Equal Weight ETF (RSP) also tracks the S&P 500. But it charges a fee of 0.4% of assets.

Look At The Performance

“You might ask ‘Who in their right mind would pay 40 basis points vs. 9?'” said Ron Delegge, founder of ETFguide. “But then you take a look at the 10-year return.”

RSP returned an average annual 9.42% in the past 10 years, compared with 7.85% for SPY, according to Morningstar. In fact, RSP beats SPY in all periods reported on Morningstar.com, from one month on.

The big difference between the funds is the way the indexes are weighted. SPY follows the S&P 500’s classic market-capitalization weighting, which multiplies the stock price by the number of shares outstanding to get a stock’s market value. The biggest companies get a larger weighting, comprising a greater percentage of the index than the smaller ones. Thus a $1 move in Apple (AAPL), with a 3.98% weighting, will lift or drag down the index much more than a $1 move in the shares of Diamond Offshore Drilling (DO), which has a weighting of just 0.01%.

But RSP gives every stock in the index an equal weighting of 0.2%. This means a $1 rise in Diamond Offshore’s stock moves the index just as much as a $1 increase in Apple’s shares. By giving greater weight to the smaller stocks in the index, this has a big effect on the fund’s performance. Year to date, RSP is up 2.25% vs. SPY’s 1.29%, 96 basis points more — after paying the expense ratio.

“Would I be willing to pay more for those returns?” asks Delegge. “Definitely.”

Of course, SPY could just as easily outperform RSP in periods when the market favors large-cap stocks or other factors that can be found in SPY but not RSP.

But S&P 500 trackers aren’t alone. “One example that is much maligned is PowerShares FTSE RAFI U.S. 1000 ETF (PRF), said Michael Krause, president of AltaVista Research in New York, which runs the ETF Research Center website. “I calculate that cumulative since its inception in 2006, PRF has outperformed iShares Russell 1000 ETF (IWB) by 14 percentage points.”

ETF Research Center pegs PRF’s average annual return since 2006 at 8.9% vs. 8.1% for IWB.

PRF’s expense ratio is 0.39%, while IWB charges 0.15% of assets.

Not Alone

This trend happens a lot among the industry ETFs. SPDR S&P Homebuilders ETF (XHB) and iShares U.S. Home Construction ETF (ITB) sound like they track the same industry, meaning they should post similar results. XHB charges 0.35%, while ITB charges 0.45%, so XHB seems like a better choice.

Yet only 35% of the XHB holdings are actual homebuilding companies, and 28% building products. The rest of the stocks are home furnishing producers and retailers, home improvement retailers and household appliance makers. However, homebuilding companies make up 71% of the ITB portfolio, with building products at 13%.

ITB has risen by an annual average of 25.72% in the past three years vs. 21.01% for XHB. Year to date, ITB is up 8.32% vs. XHB’s 6.74%. That more than compensates for the extra 10 basis points.

“Cheaper hasn’t been better as of late,” said Rosenbluth.

Originally published in Investor’s Business Daily.

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ETFs Flooded With New Money

Investors flooded ETFs with new money last week, pushing most of the cash into equity funds, even as they pulled dollars out of commodity and bond ETFs.

The $16.7 billion of net inflows that came in during the five days ended July 12 was the largest weekly total of the year, according to a report Morgan Stanley released Tuesday.

The SPDR S&P 500 ETF (SPY) was the star of the week. The ETF better known as the Spyder dramatically reversed its net outflows for the previous 12 weeks by bringing in half of the industry’s total net inflows for the week with $8.37 billion. It was the Spyder’s largest net inflow since the week of March 12, 2012.

With the Spyder leading the way, U.S. large-cap ETFs generated net inflows of $15.1 billion over the last 13 weeks, the most of any category, said Morgan Stanley. The Spyder accounted for 54% of that total. The total net inflow for all U.S. equity ETFs was $17.3 billion and the combined net inflows for all of ETF Land was $29.0 billion.

Year-to-date, total ETF assets in the U.S. have increased by 11% to $1.5 trillion. Net inflows year-to-date total $92.2 billion.

The commodity ETF category saw the biggest net outflows, losing $636 million for the week. However, all of that came from the SPDR Gold Trust (GLD), which posted a weekly net outflow of $900 million. Over the past 13 weeks, commodity ETFs have seen net outflows of $11.73 billion, with GLD accounting for $9.62 billion. The Gold Trust hasn’t posted a net inflow in the past 32 weeks, bringing its market capitalization down to $38.78 billion.

Emerging-market ETFs was the second-worst category, with net outflows for the week at $624 million and for the 13 weeks at $11.05 billion. The iShares MSCI Emerging Markets ETF (EEM) posted the second largest net outflows for the week and 13-week periods at $386 million and $7.03 billion, respectively. In a reflection of the faltering economy in China, the iShares MSCI China ETF(MCHI) had a net outflow of $246 million last week.

Fixed-income ETFs also went negative, posting weekly net outflows of $419 million. For the 13 weeks ended July 12, bond ETFs saw net outflows of $511 million as investors moved into short-duration fixed income and U.S. equity ETFs, said Morgan Stanley.

Among the ETFs market participants expect to fall, the Spyder saw the largest increase in short interest, at $2.0 billion, according to Morgan Stanley. This is the highest level the leading ETF has been at since April 15, and is nearly 10% about the one-year average.

Even as the CurrencyShares Euro Trust (FXE) gained 6.3% over the past year, it continues to be one of the most heavily shorted ETFs as a % of shares outstanding, says Morgan Stanley.

Guggenheim to Close FAA and 8 Other ETFs

And the death knell continues.

Guggenheim Investments announced Friday it will liquidate in March nine exchange traded funds that have under performed in terms of gathering assets. The New York firm said it will focus resources on products that have demonstrated the most demand. The nine ETFs together hold a total of $144 million, roughly 1% of Guggenheim’s $13.7 billion in ETF assets. That’s an average of $16 million in assets per fund.

“Guggenheim remains committed to the ETF business,” said William Belden, head of product development. Guggenheim Investments, the investment management division of Guggenheim Partners, has become the eighth-largest ETF provider since purchasing the Claymore and Rydex ETF families.

The nine funds to close:

Guggenheim ABC High Dividend ETF (ABCS)
Guggenheim MSCI EAFE Equal Weight (EWEF)
Guggenheim S&P MidCap 400 Equal Weight ETF (EWMD)
Guggenheim S&P SmallCap 600 Equal Weight ETF (EWSM)
Guggenheim Airline ETF (FAA)
Guggenheim 2x S&P 500 ETF (RSU)
Guggenheim Inverse 2x S&P 500 ETF (RSW)
Wilshire 5000 Total Market ETF (WFVK)
Wilshire 4500 Completion ETF (WXSP)

The most shocking of the bunch is the Guggenheim Airline ETF, the only ETF to track the airline industry. And of course, the disappearance of that great ticker, FAA. Granted the airline industry is a notoriously risky investment. Still, it’s pretty shocking that this fund has only $20.7 million in assets under management and an average daily volume of just 9,000 shares considering it surged 33% in 2012, twice the gain of the S&P 500. And year to date, FAA is up 13.6% vs. the 7.6% rise in the S&P, according to Morningstar.

Most ETF liquidations occur in funds that have a small-niche appeal. So, it’s disheartening that an ETF following the index that tracks the entire stock market, the Wilshire 5000 Total Market ETF (WFVK), couldn’t garner more than $9 million in assets.

The liquidating funds’ last day of trading on the NYSE Arca and the final date for creation and redemption activity is expected to be Friday, March 15, 2013. The ETFs will be delisted, Monday, March 18. Shareholders remaining in the affected ETFs as of close of business March 21, will have their shares liquidated as of that date’s closing net asset value. The liquidation proceeds will be distributed on or about March 22. The net asset value of each affected ETF on March 21 will reflect expenses encountered in closing the ETF.

Webinar to Teach How to Evaluate Corporate Bond ETFs

Matt Hougan, IndexUniverse’s President of ETF Analytics, and Jason Bloom of Guggenheim Partners will lead a webinar on how to evaluate corporate bond ETFs and what special risks and opportunities should you be aware of? It will teach tactical approaches to corporate bonds such as managing the yield curve to enhance yield and evaluating credit spreads, duration and other key fixed-income metrics.

It will be held at 2 pm EST on Thursday, February 23.

FAA Pops On AMR Bankruptcy

American Airlines filed for bankruptcy protection today and shares of AMR, its parent company, took a nose dive, plummeting 84% to 26 cents, as it too declared bankruptcy.

The third-largest airline, in terms of traffic, whined that it couldn’t compete with the other big U.S. airlines, because they had all cut costs by declaring bankruptcy at least once during the last decade, while American had not.

However, the entire airline industry has been funk due to higher fuel prices and an lagging economy that leaves many consumers taking fewer flights. The industry’s troubles can be seen in the 40% decline in the Guggenheim Airline ETF (FAA).  Not that this should be any surprise. A year ago, I basically declared the industry had peaked in my story Flying High With Airline Stocks.

Surprisingly, the ETF jumped 22 cents to $25.25 on Tuesday because other airline stocks popped. It appears American’s woes could be a boon for the rest of the industry as they take over some of its routes. This move is a good example of why ETFs are better investments than single stocks. Not only did the ETF’s diversified portfolio protect it against AMR’s troubles, but by holding the entire industry, the ETF registered a gain.

Zacks says the ETF is worth watching as the bankruptcy plays out and the competitors move in on its hubs. But I think you should just stay away. Oil prices will continue to hurt airline income statements. Not to mention the potential fallout from the European debt crisis.

It’s Not the Heat; It’s the Liquidity

It’s not the heat, it’s the liquidity, says Nouriel Roubini on why Italy’s days in the eurozone are numbered.

Even as stocks and Italian bonds posted a recovery after Wednesday’s surge in Italian yields, Roubini, better known as Dr. Doom, said in the Financial Times, the only way to avert “the upcoming disaster is “if the ECB became an unlimited lender of last resort and cut policy rates to zero”, combined with the euro’s value falling to even with the dollar, “fiscal stimulus in Germany” and the deflation in the eurozone’s. Since the ECB can’t do that without rewriting the eurozone treaties, it doesn’t really matter that the other four are basically impossible as well. More to the point, even if Italy isn’t insolvent, the lack of liquidity in its system could be just as fatal.

Meanwhile, an extremely cute economist named Megan Greene agrees with Roubini. Greene has been waiting for the eurozone to go “into full meltdown mode” for months. She says “the only possible way Italy could regain market confidence at this point is if it swiftly implemented a package of austerity and structural reforms under a government with cross-party consensus and a strong, respectable leader, and this package immediately yielded results. This is nearly impossible.” Of course, being cute has nothing to do with it. She writes a blog called Euro area debt crisis. I’m going to assume that if your blog title is that specific, you’ve got a pretty good read on the situation. My favorite tab on the blog is “Beyond the Pigs.” It lends itself to so many interpretations.

Roubini says Italy, and the next bailout in line, Spain, are “too-big-to-fail but also too-big-to-save,” and will need a restructuring of 1.9 trillion euros of public debt. However, the European financial stability facility has already committed half of its resources to Greece, Ireland and Portugal, leaving just 200 billion euros for Italy and Spain. Efforts to leverage that 200 billion euros to 2 trillion, “is a turkey that will not fly, because the original EFSF was already a giant collateralized debt obligation, where a bunch of dodgy, sub-triple-A sovereigns try to achieve, by miracle, a triple-A rating via bilateral guarantees.” He calls it another “a giant sub-prime CDO scam.”

Still Wall Street isn’t going down easy. After Italy passed an austerity measure, the S&P 500 jumped 2% to 1264 and the Dow Jones Industrial Average climbed 2.2% to 12158. The yield on Italy’s benchmark bonds fell to 5.69%.

The rebound was so strong that some of the ETFs that tumbled on Wednesday are now trading above Tuesday’s close. These include the PowerShares DB Italian Treasury Bond Futures ETN (ITLY) up 3% to $18.25 and the PowerShares DB 3x Italian Treasury Bond Futures ETN (ITLT) up 10% to $14.29. These ETNs measure the performance of a long position in Euro-BTP futures, whose underlying assets are Italian government debt with an original term of no longer than 16 years. The ITLT ETN provides leveraged exposure three times greater than the unleveraged bonds.

Meanwhile, while not above the Nov. 8, close, these still made a nice recovery. The iShares MSCI Italy Index Fund (EWI), which tracks about 85% of the Italian equity market, gained 4% to $13.24 and the CurrencyShares Euro Trust (FXE), which offers U.S. investors a way to bet on the euro without trading on the foreign exchange markets, climbed back to $137.

Stocks, ETFs Plunge as Italian Bonds Top 7%

If you had any hopes that Europe would get its act together and come up with a reasonable plan to deal with its debt crisis, I think it’s time to give the points to the cynics.

Italian bond yields spiked to 7.25% today on fears that Italy has replaced Greece as the next flash point in the European debt crisis. People were hoping Italy would be able to institute some austerity measures if Italian Prime Minister Silvio Berlusconi stepped down. However, news that Berlusconi had pledged to resign, and his insistence on elections instead of an interim government, instead sent markets reeling.

With Italian bonds hitting an all-time high since the euro’s 1999 introduction, they reached the same level that forced Greece, Ireland and Portugal to seek bailouts. This sent U.S. stocks plunging. The S&P 500 Index tumbled 47 points, or 3.7% to 1229.

The evaporation of investor confidence was clear by the movement of ETFs that track the Italian bond and equity markets. The PowerShares DB Italian Treasury Bond Futures ETN (ITLY) fell 3% to a new low of $17.38 and the PowerShares DB 3x Italian Treasury Bond Futures ETN (ITLT) sank 10.3% to $12.37. These ETNs measure the performance of a long position in Euro-BTP futures, whose underlying assets are Italian government debt with an original term of no longer than 16 years. The ITLT ETN provides leveraged exposure three times greater than the unleveraged bonds. They have expense ratios of 0.5% and 0.95% respectively. If you’re looking for a good way to short the Italian bond market, these offer a good proxy. Just be aware, the ETNs are unsecured debt notes subjected to Deutsche Bank’s credit risk.

After months of failed plans, it’s become apparent that the European politicians are unable to make the hard choices to avert a disaster and that this has all been a huge shell game to push the problem forward without actually doing anything. I think it’s time for people to get out of U.S. stocks. We’re in for another hard landing.

Other ways to take advantage of the clustercuss that I fear will soon envelope Europe are the iShares MSCI Italy Index Fund (EWI), which tracks about 85% of the Italian equity market, and the CurrencyShares Euro Trust (FXE), which offers U.S. investors a way to bet on the euro without trading on the foreign exchange markets. The MSCI Italy fund, which charges 0.54%, plummeted 9.4% to $12.30, while the Euro Trust, which charges 0.4%, fell 2% to $135.03.

With Berlusconi demanding new elections, he effectively leaves Italy leaderless at the depths of the crisis, bringing the country close to a breaking point.

Meanwhile, late Wednesday, Greek Prime Minister George Papandreou did officially quit, without naming a successor.

It’s hard to see things getting better soon. The market’s recent bounce gave most people an opportunity to get out of the market with some profits. I think it’s a good time to go to cash.

Hennessy Continues Cautious View on Economy

Even as the stock market surged on Thursday, Neil Hennessy, chairman and chief investment officer of the Hennessy Funds, continues to hold a cautious outlook for stocks and the economy.

The Dow Jones Industrial Average jumped 340 points Thursday, or 2.9%, to 12209, while the S&P 500 soared 43 points, or 3.4%, to 1285 after bondholders of European debt were browbeaten by politicians into accepting at 50% write-down to their Greek debt.

While the bondholders’ new Greek haircut removes one black cloud hanging over the markets, Hennessy believes there’s enough negativity in the U.S. economy to remain wary of the near future.

On Tuesday, Hennessy announced the rebalancing of his portfolio for his Focus 30 Fund. He screens for five variables, market cap between $1 billion and $10 billion, no foreign stocks, price-to-sales ratio below 1.5, growth in annual earnings, and stock price appreciation over last six months. This strategy has given the fund a 21.7% annualized return over the past three years, beating the S&P 500’s 17.4%. But over the past year the fund underperformed the index by 50 basis points to 10.37%, as of Oct. 27.

A closer look at the portfolio changes gives an idea of what Hennessy thinks will be the growth sectors next year. The biggest changes were consumer discretionary fell from 50% of the portfolio to 30%, while utilities jumped from 0% to 30%, and consumer staples from 0% to 10%. Meanwhile, financials, health care, and materials all fell to zero. With consumer discretionary down and utilities and consumer staples up this long-term growth mutual fund is so defensive it looks like they’ve battened down the hatches for a big storm.

Much like when I spoke with Hennessy a year ago, he continues to feel one of the biggest problems for business is the lack of leadership in Washington.

One of the biggest issues is that the Dodd-Frank regulations remain mostly unwritten. Without a clear understanding of what the government plans to do about new regulations, taxes, or the new healthcare plan, Hennessy says few companies are willing to hire. And with the presidential campaign picking up steam, he has little hope of clarity before the election.

With unemployment high, economic growth remains low, he added. Highlighting his sentiment is U.S. consumer confidence fell in August to its lowest level since March 2009. Also in August, investors pulled the most money out of mutual funds since October 2008, right after the Lehman Brothers bankruptcy.

With the yield on the Dow Jones Industrial Average at 2.9%, Hennessy says, just like last year, companies will focus on dividends, either initiating or increasing existing ones, as a way to drive their stock prices higher. Meanwhile, the Dogs of the Dow, the ten highest-yielding stocks in the Dow industrials, currently yield 4.1%, or 30% higher than the 3.2% yield on the 30-year U.S. Treasury Bond. The Hennessy Total Return Fund is a mutual fund that tracks the Dogs of the Dow strategy.

Hennessy says stocks are cheap because market fundamentals, such as price-to-sales, price-to-book, price-to-cash-flow and price-to-earnings, are significantly below their 5-year and 10-year averages. The market’s P/E ratio is currently a multiple of 13, compared to its 5-year average of 16.

If you want to focus on the two main sectors of the Focus 30 Fund check out the Utilities Select Sector SPDR ETF (XLU) or the Consumer Staple Select Sector SPDR ETF (XLP).

Five good ETFs for dividend investing:
SPDR S&P Dividend ETF (SDY)
WisdomTree Emerging Markets Equity Income Fund (DEM)
iShares S&P U.S. Preferred Stock Index Fund (PFF)
First Trust DJ Global Select Dividend Index Fund (FGD)
Guggenheim Multi-Asset Income ETF (CVY)

For my full analysis of these five ETFs go to Kiplinger.com.

Rydex to be Part of Guggenheim by Year End

Last night at the Seeking Alpha cocktail party in Tribeca, I spoke with some staff members at Guggenheim Funds. First reported on this blog in December, it appears that Guggenheim Partners, the parent company, is still involved in talks to combine the former Claymore Funds, renamed Guggenheim Funds, with Rydex, another ETF company it bought last year. The staffers say Rydex should be made part of Guggenheim funds by the end of the year.

RGI Gives an Industrial-Strength Performance

Rydex S&P 500 Equal Weight Industrials ETF (RGI) offers investors an uncommon, but potentially lucrative, way to diversify their exposure to the stocks of large and midsize industrial companies.

This exchange-traded fund tracks the industrial sector of Standard & Poor’s 500-stock index. But instead of weighting the stocks by their market capitalizations, the approach used in most indexes, the Rydex fund assigns each stock an equal weighting.

In traditional market-cap-weighted benchmarks, large companies are much more influential than small firms. For example, the five biggest S&P industrials account for 32% of the index, with General Electric alone representing 11%. In the Rydex ETF, each stock counts for about 1.8%. The effect is to give smaller companies, such as Cintas and Masco, as much weight as Goliaths such as GE.

So far, Rydex’s approach has paid off. From the ETF’s November 2006 launch through May 6, it gained 6.2% annualized. That compares with 3.9% annualized for the Dow Jones industrial average and 5.2% for the market-cap-weighted S&P industrials. (The fund charges 0.50% in annual expenses.) And with manufacturing output having jumped at an annual rate of 9.1% in the first quarter of 2011, industrial stocks look appealing.

Big moves in individual stocks can throw an equal-weighted index out of whack. Rydex seeks to keep positions close by rebalancing its holdings quarterly.

For the full story with chart go to Kiplinger.com.