As the exchange traded fund universe expands, it is understandable that some fund providers may launch competing products that cover the same market segment. Consequently, new ETF investors will have to dig a little deeper to find their best fit.
Beyond just comparing the name of similar ETFs, potential investors should look at a fund’s indexing methodology, holdings, costs and trading activity, writes Aparna Narayanan for Investor’s Business Daily.
What’s in a name? Similar-sounding ETFs can have very different investment strategies. Specifically, their underlying indices can provide vary weighting methodologies and select stocks based on various factors.
For instance there are a number of ETFs with the S&P 500 appellation, but these ETFs are not all created equal. The largest S&P 500 ETF options, like the SPDR S&P 500 ETF (NYSEArca: SPY), track an index that weights holdings by market capitalization, so the largest companies have the largest position. There is also an equal-weight S&P 500 ETF, the Guggenheim S&P Equal Weight ETF (NYSEArca: RSP), that equally weights each of its holdings regardless of asset size. Additionally, the PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV) tracks S&P 500 stocks that exhibit the lowest volatility. [How to Utilize Smart-Beta ETFs in Your Portfolio]
What does the fund hold? Different ETFs are managed differently. Even if two ETFs track the same market, each fund will not have perfectly equal weights in each underlying holding.
“What are you actually buying in an ETF? Investors should be mindful of the methodology because despite the names or investment objectives of two ETFs being similar, their country, region and sector exposure could be significantly different,” Philip Blancato, chief executive of Ladenburg Thalmann Asset Management, said in the article.
What’s this going to cost me? Depending on how an ETF’s portfolio is crafted, the fund’s expense ratio can vary. For instance, U.S. stock ETFs, which can be easily replicated, typically cost less than international stock ETFs where overseas markets are harder to access. Additionally, smart-beta and actively managed ETFs, which both utilize more sophisticated stock-picking methodologies, will typically cost more than traditional beta-index ETFs.
According to XTF data, the average expense ratio of U.S.-listed ETFs is 0.60%, with the cheapest one coming in at 0.04%. In contrast, the average expense ratio for an actively managed U.S.-listed ETF is 0.85%.
What other factors can affect returns? Blancato argues that investors should focus on the ETF’s liquidity. ETF liquidity is based on the number of ETF shares traded, along with the liquidity of the fund’s underlying market. [The Total Costs of Owning, Trading ETFs]
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.