Why Buy A More Expensive ETF When A Similar Cheaper One Is Available?

The lowering of expense ratios is one of the biggest trends in the exchange traded fund industry today.

 

Yet two of the biggest ETF providers, BlackRock’s iShares and State Street Global Advisors, offer funds that charge significantly more than other funds they offer with similar exposures. Why would an investor choose the more expensive fund?

A prime example is iShares MSCI Emerging Markets (EEM), which tracks the MSCI Emerging Markets Index, the most widely followed benchmark in the emerging-market sector. It charges an expense ratio of 0.72%.

But the company offers a very similar fund, iShares Core MSCI Emerging Markets (IEMG), which only charges 0.14%. What’s the difference? While the MSCI Emerging Markets Index is primarily made up of large-cap stocks, the cheaper fund follows a multicap index, the MSCI Emerging Markets Investable Markets Index, which holds more than twice as many components, including all the stocks in the first index plus midcap and small-cap stocks.

With broader market exposure and a lower expense ratio, IEMG, which was launched in October 2012, is the more popular fund, with $40 billion in assets. But even with its drawbacks, EEM (which dates back to April 2003) still weighs in with $37.7 billion in assets.

Why does iShares continue to offer such an expensive fund — and why does it still attract investors?

Five years ago, iShares launched its Core Series of ETFs, a suite of 10 equity and fixed-income funds aimed at the buy-and-hold investor with dramatically lowered expense ratios. There are now 25 Core ETFs. The majority have expense ratios lower than 0.1%, and none is higher than 0.25%.

“IShares launched their Core Series at a time when they were losing market share to Vanguard because many of their core products chiefly were not priced competitively,” said Ben Johnson, Morningstar’s director of global ETF research. “It was part defense, part offense to stop the bleeding of the market-share losses to Vanguard.”

And fees play a major but not absolute role in the returns of the similar but not identical emerging-market ETFs, much as one would expect. In the year ended Oct. 31, EEM actually inched higher with a 25.64% return vs. 25.58% for IEMG. But over time, the cheaper fund has posted better results: an average annual 5.6% vs. 5.06% for the past three years and 4.92% vs. 4.22% for the past five years. The difference is practically the difference in the expense ratios.

Funds like EEM that track established benchmarks seem to be attracting traders and institutional investors who hold ETFs for shorter periods of time and aren’t as concerned about the expense ratio. Traders may use these ETFs because they are more available for borrowing to sell short and have a much deeper options and swaps ecosystem.

“There is an appeal for that product, which they are more familiar with and continue to use,” said Todd Rosenbluth, director of ETF and mutual fund research at CFRA Research. “For others the appeal is the considerably more volume and greater liquidity.” EEM trades 49 million shares a day, while IEMG has an average daily volume of 7 million shares.

Rosenbluth says the situation is the same with iShares MSCI EAFE (EFA), which tracks the widely followed benchmark for the developed nations, the MSCI EAFE Index, and has an expense ratio of 0.33%. That compares with iShares Core MSCI EAFE (IEFA). The core fund tracks the broader MSCI EAFE IMI Index and charges only 0.08%.

EFA is much more liquid, with average daily volume of 15 million shares vs. IEFA’s 4 million shares.

Meanwhile, State Street, realizing it was already late to the game where investors were demanding lower fees, decided that it would take too long to build assets and get onto important trading platforms if it created a new line of funds, said Matthew Bartolini, head of SPDR Americas research.

Instead, the firm decided to restructure a group of existing funds that already had assets and a user base. They rebranded 15 funds to make a consistent suite called the SPDR Portfolio, cut the fees, split the share prices so that they all started at $30, and if needed changed the index. Well-known funds such as SPDR S&P 500 (SPY) and SPDR S&P MidCap 400 ETF (MDY) weren’t changed for the same reasons EEM still exists.

“In order to be successful and have an impact for clients in a low-cost arena, you can’t just cut fees,” said Bartolini. “So we restructured 15 funds across every key asset class in equity and fixed income and aggressively cut costs to be the lowest or match the lowest price in the marketplace.”

The upshot is that traders might prefer the older indexes even if they’re a bit more expensive, while buy-and-hold investors might prefer the cheaper versions.

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SPDR Jumps 32.3% in 2013

Last year was a banner year for U.S. stocks and the ETFs that tracked them.

• Large caps in the S&P500 SPDR (SPY) soared 32.3%, their best performance since 1997, topping the index’s 29.6% rally.
• Small caps in the iShares Russell 2000 (IWM) surged 38.7%.
• All U.S. sectors posted gains:
• Consumer Discretionary Select Sector SPDR (XLY) rocketed 42.7%.
• Health Care Select Sector SPDR (XLV) surged 41.4%.
• Industrials Select Sector SPDR (XLI) soared 40.5%.
• Financials Select Sector SPDR (XLF) jumped 35.5%.
• Consumer Staples Select Sector SPDR (XLP) rose 2.63%.
• Energy Select Sector SPDR (XLE) leapt gained 26.3.%.
• Materials Select Sector SPDR (XLB) advanced 26.0%.
• Technology Select Sector SPDR (XLK) climbed 26.3%.
• Safe haven Utilities Select Sector SPDR (XLU) did the worst, but still gained 13.0%.
• Outside the U.S., developed markets tracked by the iShares MSCI EAFE ETF (EFA) gained 21.4% as investors noticed Europe’s bargain valuations and Abenomics fueled a rally in Japan.
• However, the iShares MSCI Emerging Markets (EEM) lost 3.7% as the resource-dependent economies of Brazil and South Africa saw sizeable declines.

All results are total returns, with dividends factored in

Small ETFs Struggle as 18 Funds Hold Half of Industry’s Assets

If you’re looking for a reason why many of the ETFs launched last year failed to raise the $30 million in assets necessary to turn a profit and stay open take a look at the $10 Billion Club.

While there are more than $1 trillion in assets in the entire U.S. ETF industry, the majority are confined to about 100 funds, “leaving the other 1,300 ETFs in the dust,” says ETF Database.

Yesterday, I said many investors remain risk-adverse in today’s volatile market, leaving them squeamish about buying into hypertargeted ETPs. They prefer to stick with big, liquid funds tracking well-known indexes both because they understand what the index tracks and because they can get out quickly in an emergency. Other reasons why small, niche funds are having a hard time gathering assets is because institutional investors and investment advisors are restricted to buying products with minumum requirements for assets under management, average daily volume and age of the fund.

This leaves just 18 ETFs holding nearly half the assets of the entire ETF industry, according to ETF Database, which calls the group the $10 billion club because they all have more than that under management.

It’s no surprise who tops the list:

SPDR S&P 500 (SPY)
SPDR Gold Trust (GLD)
Vanguard MSCI Emerging Markets ETF (VWO)
iShares MSCI EAFE Index Fund (EFA)
iShares MSCI Emerging Markets Index Fund (EEM)
iShares S&P 500 Index Fund (IVV)
PowerShares QQQ (QQQ)

The big surprises to my eyese were the iShares iBoxx $ Investment Grade Corporate Bond Fund (LDQ) and the iShares iBoxx $ High Yield Corporate Bond Fund (HYG).

Apple’s Worth More Than Top 5 ETFs Combined

I don’t have anything to say about Steve Jobs that hasn’t already been said, except that there’s no doubt he was a genius. Much like Apple’s Think Different ad campaign, a genius isn’t just smart, but someone who sees or hears things so differently from the conventional wisdom that he completely changes the paradigm. While Dizzy Gillespie and Charlie Parker didn’t invent jazz, the BeBop they created was a sound so completely different than what had come before that they forever changed the way jazz was played. So while Jobs didn’t create the personal computer, MP3 player or the cell phone, his vision completely changed the way those industries operate.

Over the course of the many Steve Jobs accolades, I stumbled upon the fact that Apple’s market capitalization, at around $355 billion, is larger than the 5 largest ETFs combined. At the end of September, that was $247.5 billion, according to the National Stock Exchange.

The top five ETFs in order of size are:
SPDR S&P 500 (SPY) – $81.2 billion
SPDR Gold (GLD) – $64.1 billion
Vanguard MSCI Emerging Markets (VWO) – $39.8 billion
iShares MSCI EAFE (EFA) – $35.0 billion
iShares MSCI Emerging Markets (EEM) $27.5 billion.

Apple’s stock movement alone has more of an impact on the stock market than there five combined. Which I think nicely puts into perspective the common fallacy that ETFs have the potential to destroy the market.

9 ETFs Make Up 18% of Total U.S. Volume

Abel/Noser, an agency-only broker, released a market liquidity study for July saying ETFs dominated trading on the U.S. stock markets, with nine ETFs representing 18% of the total daily domestic volume, reports StreetInsider.com.

Those nine ETFs were: the SPDR (SPY), iShares Russell 2000 Index (IWM), PowerShares QQQ (QQQQ), iShares MSCI Emerging Markets Index (EEM), SPDR Gold Shares (GLD), UltraShort S&P500 ProShares (SDS), iShares MSCI EAFE Index (EFA), Financial Select Sector SPDR (XLF) and Direxion Daily Financial Bull 3X Shares (FAS).

According to the July ETF Report released by the National Stock Exchange today, the top five ETF providers in terms of volume, in descending order, are State Street Global Advisors, BlackRock, ProShares, Direxion and Invesco/PowerShares. Together, their share volume for the month of July was 27.6 billion shares, or 54% of the NYSE Group Volume in all stocks traded, 50.6 billion shares. This number doesn’t include Nasdaq volume.

In addition, Abel/Noser said six stocks accounted for more than 10% of the domestic principal traded. The six stocks: Apple, Bank of America, Citigroup, Microsoft, Exxon Mobil and Intel.

The top 105 stocks represented more than half of the day’s volume, says the study, while the top 975 names accounted for 90% of all the volume. The renaming 17,399 securities accounted for just 10% of the daily volume on the market. These numbers were little changed from June.

GlobalShares Takes on EAFE

GlobalShares made its second foray into the ETF market last week with a mild twist on an old favorite, it adds Canada to the developed world outside the U.S. The GlobalShares FTSE Developed Countries ex US Fund (GSD) launched Feb. 10 on the NYSE Arca. It tracks the FTSE Developed ex US Index, which is comprised of more than 1,400 stocks in 23 developed countries, including Japan, the United Kingdom, France and Germany.

It’s a pretty bold move considering GSD is going against one of the most popular funds on the market, the iShares MSCI EAFE Index Fund (EFA). The MSCI EAFE, which stands for European, Australasian, and Far Eastern markets, is the most popular benchmark for tracking the world outside the U.S. It’s the fourth largest ETF in the world, according to the National Stock Exchange, or NSX, with $33.64 billion in assets under management.

Right off the bat, both funds have the same top ten holdings, although with different weightings. GlobalShares representatives call it the low-cost alternative. However, it charges the same 0.35% as EFA. In fact, the real low cost alternative is the Vanguard European Pacific ETF (VEA), which also tracks the MSCI EAFE, for just 0.16%. VEA is the 37th largest ETF in the U.S. with $4.22 billion in assets, according to the NSX. In addition, the bigger funds offer instant liquidity and very low volatility.

With 7.1% of the GSD portfolio, Canada will make the big difference here. Cinthia Murphy of IndexUniverse says Canada “carries a lot of weight in the commodities markets, and commodities have been a hot ticket in recent months.” She adds WisdomTree and PowerShares have ex-U.S. funds with Canadian stocks, but these don’t have a market-cap weighting like the GSD.

GlobalShares says over the past ten years, the FTSE Developed ex US Index beat the MSCI EAFE 2.58% to 1.79% on an annualized basis. However, commodities have taken a hit lately, and the one month returns favors the EAFE -4.40 vs. -4.77

GlobalShares is the ETF unit of Old Mutual Global Index Trackers, an index tracker/fund manager with the bizarre abbreviation OMGxT. Looks like “Oh My God” times taxes. OMGxT is a unit of mutual fund stalwart Old Mutual, an asset manager with $400 billion under management. Based Johannesburg, South Africa, the 165 -year-old firm became the first African company to list an ETF on the New York Stock Exchange with the December launch of the GlobalShares FTSE Emerging Markets Fund (GSR), which tracks the FTSE Emerging Markets Index. That fund also takes on the big boys, especially the iShares MSCI Emerging Markets Index Fund (EEM), the third largest ETF in the world, with $35.53 billion in assets.

Old Mutual expects to launch three more ETFs within the coming weeks.

Book Review of ETFs for The Long Run

Research Magazine just came out with a supplement called the Guide to ETF Investing 2009. Some great articles in there.

On page 8 of the guide is a review of my book ETFs for the Long Run. The link goes to a PDF file. The article was written by Ron DeLegge, the editor of ETFGuide.com, a great resource for ETF information. I am reprinting it here because I can’t link directly to the article.

Long-Term Thinking

Mutual funds may have enjoyed a 65-year head start, but the interest in ETF investing by individual investors and financial professionals is blossoming. Naturally, the rise of ETFs has led to a proliferation of subject material related to this still emerging investment vehicle. ETFs for the Long Run tackles this growing investment universe in a fun, readable and easy-to-comprehend manner.

The first few chapters take readers through a brief review of how ETFs came about. Nathan Most, a product developer for the Amex was instrumental in helping to launch the U.S. ETF marketplace. Most asked his development team, “Why can’t we create a warehouse receipt which would be backed by the underlying stock in the index but trade like a share of stock itself?” His question would later be answered with product prototypes that would eventually lead to the first U.S.-listed ETF in 1993, the Standard & Poor’s Depository Receipt (SPY).

Author Lawrence Carrel writes about ETFs as being a “better mousetrap.” He argues that mutual funds are inefficient from a cost standpoint: “Funds charge their shareholders for everything that goes on inside the fund, such as transaction fees, distribution charges, and transfer-agent costs.” On top of these costs, Carrel explains that there are additional charges that erode performance such as capital gain distributions. These often have the ugly habit of surprising mutual fund investors.

Timing Trouble

Remember the mutual fund timing scandal from 2003? Carrel suggests the 2003 scandal actually helped to fuel the popularity of ETFs. As you may recall, mutual funds were accused of breaking their own rules by allowing a select group of privileged investors to late-trade and market-time within their funds. On one hand, fund companies were telling investors to be long-term investors. On the other hand, these same companies were allowing hedge funds to make quick short-term profits at the expense of long-term investors. In contrast, ETFs avoided becoming tainted by the scandal because ETF investors are unaffected by the trading activity of their fellow shareholders.

ETFs for the Long Run explains the importance of building an ETF portfolio that accomplishes a logical financial mission. Carrel cites the classic 60/40 conservative portfolio which has substantially less exposure to stocks and more exposure to bonds. He suggests an equity mix using SPY, VO, IWM and EFA. For the bond position, he uses BSV, BLV, CFT and TIP. He also throws in a REIT fund (VNQ) for non-correlated market exposure.

Future Tense

Toward the end of the book, Carrel considers what the future of the ETF marketplace could become. While active ETFs have yet to make any significant impact in the business, the number of active mutual funds outnumbers that of index mutual funds. Could the same thing eventually happen with ETFs? Another area of future ETF asset growth is inside the lucrative 401(k) retirement market. Millions of 401(k) investors have no low-cost investment options or diversified choices like commodities, international bonds or REITs. Companies like Invest n Retire and WisdomTree are already aggressively pushing ETF/401(k) retirement plans. As complicated as ETF investing may sometimes seem, simplicity is often best. “The basic challenge for
the individual investor is to achieve a broadly diversified portfolio for the least amount of money,” states Carrel. This book should go a long
way to helping not just investors but top-notch financial professionals accomplish this noble objective.

ETFs See Cash Inflows Even as Asset Values Fall

ETFs and ETNs continue to see net cash inflows even as total assets under management fall. The conclusion is this is a function of just falling asset values.

According to the National Stock Exchange (NSX), at the end of November, total U.S. listed ETF and ETN assets fell 16.8% to $487.6 billion from $585.8 billion in November 2007. However, net cash inflows for the month were $26.4 billion, bringing the total net cash flow for the 11 months through Nov. 30 to $136.8 billion. In November, 315 ETFs saw net cash inflows, while 179 saw outflows. ETNs split at 16 each.

Notional trading volume in both ETFs and ETNs fell 33% in November from October to $2.2 trillion. Surprisingly, this represents a record 43% of all U.S. equity trading volume, up from 38% in October. That just shows how much total equity volume must have fallen off. At the end of November 2008, the number of listed products totaled 843, compared with 650 listed products one year ago and 806 in October.
According to the NSX, the only ETF firms that saw assets grow are State Street Global Advisers, ProShares, Van Eck and

Ameristock/Victoria Bay. All those firms saw net cash inflows for the year through Nov. 30 increase compared with the first 11 months of 2007. Vanguard did as well. ProShares’s assets under management rocketed 112% to $20.9 billion. SSGA’s assets grew 8.3% to $142.9 billion. This really shouldn’t be a surprise. ProShares sponsors the inverse and leveraged ETFs that have proved hugely popular in the market turmoil. SSGA sells the largest, most liquid ETF, the SPDR (SPY), which tracks the S&P 500. Many investors making a flight to safety or seeking a place to hold cash on a temporary basis will move to the S&P 500. Even as the S&P 500 sinks, the SPDR’s 2008 net cash inflows have surged 86% year-over-year through Nov. 30 to $18.23 billion.

Meanwhile, BGI’s iShares saw assets tumbled 29% to $229.3 billion.

Firms with net cash outflows in November included PowerShares, $309 million, and Merrill Lynch’s HOLDRs, which saw redemptions of $889 million. Surprisingly, the HOLDRs saw net cash outflows of $3.6 billion in 2007, but are up $1.2 billion so far this year. Other firms that experienced outflows in November were WisdomTree, FirstTrust, and SPA-ETF. Firms with net outflows year-to-date include Bank of New York, Rydex, X-Shares, Ziegler, FocusShares and BearStearns. The last two have gone out of business this year. Rydex is suffering as the strengthening dollar hurts its CurrencyShares.

As for ETNs, Barclay’s iPath family saw assets plunge 36% to $2.6 billion. In November, iPath saw outflows of $39 million. Morgan Stanley/Van Eck ETNs recorded outflows of $16 million in November. Meanwhile, Goldman Sach’s ETNs net cash outflows grew to $97 million year-to-date. Comparisons are not relevant for many of the other ETN firms as they had few funds, if any, last year.

Among the top ten ETFs and ETNs, the SPDR (SPY), iShares MSCI EAFE Index Fund (EFA), SPDR Equity Gold (GLD), iShares S&P 500 Index Fund (IVV), iShares Russell 1000 Growth Index Fund (IWF) and iShares Russell 2000 Index Fund (IWM) all saw net cash inflows in November, according the NSX. Of the 10 largest funds, these saw outflows last month: iShares MSCI Emerging Markets Index Fund (EEM), PowerShares QQQ (QQQQ), iShares Barclays Aggregate Bond Fund (AGG) and the Dow Diamonds (DIA).

The NYSE Group also releases volume data for its exchanges. Average daily matched volume for ETFs, or the total number of shares of ETFs executed on the entire NYSE Group’s exchanges surged 93.5% to 672 million shares from 347 million shares in November 2007. Total matched volume for the month totaled 12,765 million shares, a 75.1% increase. Total volume year-to-date through Nov. 30 jumped 74.7% from the same period last year to 102,583 million shares.

Handled volume, which represents the total number of shares of equity securities and ETFs internally matched on the NYSE Group’s exchanges or routed to and executed at an external market center, totaled 14,813 million shares last month, a 77.6% surge over the year-ago month. Average daily handled volume rocketed 96.3% to 780 million shares from 397 million shares a year ago. Year-to-date total volume climbed 78.1% to 117,629 million shares.

The NYSE also reported total ETF consolidated volume for the month leapt 92.1% to 45,151 million shares, while total average daily volume soared 112.3% to 2,376 million shares. Year-to-date, total consolidated ETF volume surged 119.4% over the first 11 months of 2007 to 355,133 million shares. I think those refer just to the NYSE Group.