Tag Archives: Ron DeLegge

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.

Podcast of My Recent Radio Appearance

I recently spoke on The Index Investing Show with Ron DeLegge. Here is a podcast of the July 25 show.

I talk about the best dividend-paying industries and the best ETFs for dividend investing. I explain how WisdomTree’s dividend-based ETFs pay dividends and mention Vanguard REIT ETF VNQ, which yields 4.6%, and the Utilities Select Sector SPDR (XLU), which yields 4.3%.

This is a podcast of the entire show, which is 45 minutes long. It’s a good show, but if you just want to hear me, I come on 33 minutes into the show.

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.