By Todd Rosenbluth, CFRA
Many investors have shifted or plan to shift their portfolios to ETFs, away from individual securities — evaluating potential ETFs based on expense ratio, other cost factors and the product’s ability to track its index. However, CFRA has concerns that if the investors’ homework ends there they may end up disappointed.
Charles Schwab (SCHW 57 *****) published the results of an online study of 1,500 ETF investors conducted by Koski Research. Three-quarters of these investors selected ETFs either solo or with the help of an advisor, with the self-reported average of investable assets amounting to approximately $800,000.
Two of the key takeaways were related to the usage of ETFs as a replacement for individual securities and the focus on costs above all else.
Approximately one-third of respondents have replaced all individual securities with ETFs, led by millennials (56%) and Gen X (41%) investors. Meanwhile, an additional 20% of all respondents are considering shifting to an all ETF portfolio.
Rather than buying dividend-paying stocks, such as Intel (INTC 55 ****) and Home Depot (HD 200 ****), investors in Schwab US Dividend Equity ETF (SCHD 51 Overweight) hold a combined 10% of assets in these stocks, but also Pfizer (PFE 36 ***), Procter & Gamble (PG 76 ****) and Union Pacific (UNP 144 ***), providing both stock and sector diversification.
Meanwhile, when considering an ETF such as SCHD or other products, respondents favored a cost focus rather than consideration of the ETF’s trading volume, historical performance or access/exposure to a specific part of the market.
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The two highest priority evaluation selections made by those ETF investors surveyed were low expense ratio and total cost (defined in the survey as commissions, expense ratio and bid/ask spread). Both of these were either extremely important or somewhat important to 95% of the respondents, followed by 94% for how well the ETF tracks its index.
Meanwhile, 64% respondents answered the ability to trade ETFs without commission or fees as the most important or a very important factor for choosing a brokerage firm. Schwab, along with TD Ameritrade Holding (AMTD 60 ***), E*Trade Financial (ETFC 65 ****) and other brokerage firms offer a select list of ETFs that can be bought and sold without commissions.
The Impact of Focusing on ETF Costs
Using U.S. dividend-focused ETFs on Schwab’s commission-free platform, let’s better understand the impact of focusing solely on costs. CFRA’s forward-looking analysis provides a more complete look at the offering. An ETF’s expense ratio and bid/ask spread are combined with technical and holdings analysis to generate CFRA’s overall ETF ranking.
SCHD has a 0.07% expense ratio and trades with a tight penny bid/ask spread. According to etf.com, the fund tracks its index well, with a median tracking difference of -0.11% in the past year, essentially in line with its expense ratio. SCHD’s stakes in CFRA Buy recommended Home Depot, INTC and PG are only partially offset by a stake in Hold recommended UNP.
A second dividend ETF offered commission free on Schwab is WisdomTree US Quality Dividend Growth (DGRW 42 Overweight). This ETF also trades with a penny spread, but charges a 0.28% expense ratio — triple the fee of SCHD. This contributes to the wider -0.43% median tracking difference shown on etf.com.
Yet in the one-year period ended June 13, DGRW still outperformed SCHD by more than 300 basis points (17.5% vs. 14.4%). To CFRA, the performance gap is the result of what’s inside these two ETFs.
SCHD had 21% of its assets in consumer staples stocks, with information technology (21%) and industrials (19%) the next biggest. In contrast, DGRW had a smaller stake in the consumer staples (9%) and a larger stake in health care (17% vs. 7%) with CFRA Buy recommended AbbVie (ABBV 98 ****) and Johnson & Johnson (JNJ 123 ****) among top positions. In 2018, the consumer staples sector was the worst performer in the S&P 1500 index, while health care was a slight outperformer.
Despite its relative performance success, investors have gravitated toward the cheaper product. Thus far in 2018, the lower-cost SCHD has $570 million of net inflows, more than double the $215 million gathered by DGRW.
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While both SCHD and DGRW earn a top rating from CFRA for their holdings, costs and more, we think investors need to go beyond finding a cheap ETF available commission free on their preferred brokerage platform. There are several dozen strong candidates offered by Invesco, iShares, SSGA, Vanguard and other asset managers worthy of consideration. The wrong choice could leave investors disappointed they did not dig deeper.
CFRA reports on more than 1,100 equity ETFs can help compare and contrast the array of ETF choices.
Todd Rosenbluth is Director of ETF & Mutual Fund Research at CFRA.