What is an ETF? — Know What Your Fund Holds

February 16th at 6:00am by Tom Lydon

In a race to gather more assets under management, exchange traded fund providers have been lowering their expense ratios over the past few months. Heavyweight providers such as Vanguard and State Street have been cutting fees, possibly distracting investors on what really matters when it comes to ETF investing.

“Although we think the cheaper expense ratios are for the better, we view these actions of two of the three largest ETF providers (BlackRock is the largest) in the U.S. as more a distraction from what we believe investors should be paying attention to,” Todd Rosenbluth, S&P Capital IQ ETF Analyst, said in a recent report. [How ETFs Have Evolved]

What investors should focus on when investing in ETFs is what the holdings are. The price tag is secondary because the holdings are going to give the investor returns, not the expense ratio. [Diversified ETFs vs. Sector Funds]

For instance, if you take the SPDR Consumer Discretionary Select SPDR Fund (NYSEArca: XLY) and compare it to the Vanguard Consumer Discretionary Index Fund (NYSEArca: VCR), the differences become apparent. Both funds hold the same five companies, but the weighting, and therefore, the performance, differs. [Why Are ETFs Cheaper Than Mutual Funds?]

VCR gives 19% of the fund’s assets to the stocks Disney (NYSE: DIS), Comcast (NYSE: CMCSA), Walt Disney (NYSE: DIS), Ford (NYSE: F) and Nike (NYSE: NKE), and spreads the rest out among 365 other shares. XLY puts about 26% in the aforementioned stocks and holds 75 other companies, reports Rosenbluth. [Race to the Bottom: ETFs Cut Fees]

And performance? VCR is up 10.5% as of Monday, while XLY is up 9.3%. VCR does weight more to small and mid-cap shares, giving the fund a riskier appeal than a pure U.S. large-cap focus.

“Unlike the three sizable ETFs tied to the S&P 500 Index, most sector-focused ETF products are not identical in their holdings because they are tied to indices with distinct constructs. As such, we strongly believe that  ETFs need to be fully analyzed to understand what is inside,” Rosenbluth said.

Tisha Guerrero 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.

Tickers

VCR