All exchange traded funds are not created equal, and this becomes most apparent when two funds tracking the same sector perform differently. One of the most important steps an investor should take is to look at what an ETF holds, before buying it.
The financial sector has fared well over the first quarter of 2012, surging upward after the October 2011 low. Overall, financials were up 39.4% and 38.8%, writes John Prestbo at MarketWatch. Both performance numbers are correct, with each one coming from an ETF from a different provider. [ETF Fees: How Low Will They Go?]
Prestbo is editor and executive director of Dow Jones Indexes.
A lot of ETF performance comes about from the way the provider classifies an index. Certain ETF providers classify sectors differently; For example, SPDRs uses the Global Industrial Classification System (GICS), which denotes consumer staples — things people need for everyday living, even in economic downturns — and consumer discretionary — things people like to buy but defer when times are tough, reports Prestbo. [Which International ETF is Best for the MSCI EAFE Index?]
However, the Dow Jones indices, on which the iShares ETFs are based, use a proprietary classification system that divides the consumer sector into goods and services. Other providers put consumer services into consumer discretionary, and goods into consumer staples.
That is just one example of the variances of ETF make-up. Another aspect to consider is what stocks the fund actually holds, and how many. If one fund holds 50 stocks and another one holds 250, the weighting and diversification will have an effect on the overall performance. [An ETF Trend Following Plan for All Seasons]
There is no rule of thumb when it comes to which type of fund will perform best. At times, a more diversified approach serves best, but at other times a concentrated ETF will outperform.
As an active investor, the responsibility will rest with them to do the research and figure out which funds will benefit their investment goals.
Tisha Guerrero contributed to this article.