As investors seek out new ways to access the international markets in a growing universe of investment options, look to a smart beta exchange traded fund strategy that could potentially enhance returns and diminish risks.
On the recent webcast (available on-demand*), ETFs vs Mutual Funds: What’s the Difference?, Steven Vannelli, CEO and CIO of Gavekal Capital, pointed out that ETF asset growth has surged in recent years whiles the mutual fund industry has seen asset growth slow. Over the last decade, assets in ETFs expanded 690%, whereas mutual funds saw assets grow 88%.
The slowing asset growth in mutual funds may be partly attributed to large outflows out of actively managed funds, which shrunk by almost $800 billion over the last decade.
Many investors have grown weary of active funds’ high costs and extended underperformance, opting for cheap index-based options instead. Consequently, Vannelli projects that at the present growth rate, ETF assets could exceed mutual fund assets within a decade.
When investing in various markets, notably international markets, the ETF wrapper may be a better investment tool to access the moves. In comparing the Morningstar World Stock ETF Average with the Morningstar World Stock Mutual Fund Category Average, Vannelli found that international stock ETFs exhibited a higher total return or generated a greater alpha with a higher Sharpe ratio. Essentially, the world stock ETFs exhibited a more attractive risk-adjusted return.
Part of the outperformance found in ETFs may be attributed to the investment vehicle’s low management fees, which eat away at total performance over time.
“The average ETF expense ratio is 64% less than the average mutual fund,” Vannelli said. “Average distributed gains for ETFs were four to 10 basis points versus 1.48% to 2.94% of NAV. Assuming a tax rate of 30%, these distributions add 50 to 100 basis points to total cost.”
The Morningstar World Stock ETF Average expense ratio is 0.46%, compared to the Morningstar World Stock Mutual Fund Category Average of 1.28%. Moreover, ETFs showed lower capital gain distributions due to their more efficient structure, which also help limit costs.