Different exchange traded funds (ETFs) that track the same benchmark don’t always provide the same results. So, when comparing them, which ETF provider has the better product? It isn’t as simple as you would think.
For example, iShares MSCI Emerging Markets Index (NYSEArca: EEM) and Vanguard Emerging Markets Stock ETF (NYSEArca: VWO) both track the MSCI Emerging Market Index; however, VWO was up around 76% last year, while EEM was up about 72%. The index itself gained 78.5%, according to Financial Advisor.
What gives?
- First, Vanguard‘s ETF has a lower fee than the iShares fund, with an expense ratio of 0.27% compared to 0.72%. The savings are passed onto investors as a higher return. It’s worth noting, though, that there’s no “right” or “wrong” on the ETF provider’s part: the market in any given year also plays a role. [Four reasons to watch emerging markets.]
- Second, ETF construction also determines performance. VWO holds around 800 stocks while EEM holds about 400 stocks. iShares chooses to limit the number of stocks in the interest of higher liquidity. Vanguard, on the other hand, can trade for the stocks with its emerging market mutual fund, which provides the necessary liquidity, and consequently, it allows VWO to have a smaller tracking error. [Why does tracking error occur?]
- Third, some ETFs that cover the same segment of the market may track different indexes. This isn’t much of a problem for large-caps, since the indexes aren’t that different, but for narrow or niche markets, benchmarks are increasingly important. A market capitalization-weighted index is usually less volatile. A fundamentally based index tends to lean toward value stocks. An equal-weighted index will usually have more small- and mid-cap stocks. [Which indexing strategy is best for you?]
For more information on ETFs, visit our ETF 101 category.
For full disclosure, Tom Lydon’s clients own shares of VWO and EEM.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.