ETFs are known for their tradability, transparency, tax efficiency and low-costs. What else is there to know?
Ben Johnson, director of global ETF research for Morningstar, argued that ETFs provide some “undersold” benefits that many investors are overlooking.
For starters, ETFs are flexible investment tools. Johnson pointed out that investors can go long ETF shares, sell short, buy on margin, buy and sell options, lend to others to collect a fee and more.
“This versatility can attract a very large and diverse investor base that uses these funds in meaningfully different ways. The diversity of ETFs’ base of investors and their use cases is the foundation of healthy liquidity in ETF shares, which benefits all investors in the fund,” Johnson said.
ETFs are also relatively predictable, which lends them a sense of reliability. Most of the funds are index-based and do not expose investors to idiosyncratic risks associated with traditional active strategies, notably management risks. With an index-based ETF, investors can rest easy, knowing that their investment is doing what it stated it will do.
“While some uber-vigilant investors might care about the contents of an ETF’s portfolio enough to examine them every day, I think that most are attracted to the stability lent by the rules dictating the selection and weighting of the constituents of their portfolios. This is embodied in their indexes’ methodologies,” Johnson said.
ETFs are tax efficient despite high turnovers
According to Morningstar data, there were 49 strategic beta ETFs with a median annual turnover in excess of 100% for the five-years ended 2017, but only nine capital gains distributions among them.
“The tax efficiency lent by the ETF structure shines through in the case of high-turnover strategies,” Johnson said.
While ETFs may be toted as cheap investments with low expense ratios, Johnson warned that the industry undersells certain cost concerns ETF traders face, such as commission charges, bid-ask spreads on trades and potential tracking errors.
“Investors should sharpen their pencils to see whether it’s worth incurring these transaction costs,” Johnson added.
For more information on ETFs, visit our ETF 101 category.