J.D. Steinhilber: Thoughts on Choosing the Right Sector ETF

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Includes: EEM, VWO
by: J.D. Steinhilber

As a prelude to our upcoming live discussion on Choosing the Right Sector ETF (this Thursday at 2pm ET), we asked J.D. Steinhilber of Agile Investing a few questions:

1. What are the key factors you're looking for when choosing a particular ETF among many available to capture a given sector?

The key factors we look at are (1) the composition of the underlying index; (2) the expense ratio; (3) tracking error – not only how the ETF tracks its index over time, but how prone the fund is to trading at a discount or premium to NAV on a day to day basis; (4) trading spreads, which should typically be under 10 to 15 basis points; (5) the stability and reputation of the fund manager; and (6) the size, or assets under management, of the fund.

2. Can you give an example of two sector ETFs that you considered, and why you chose one over the other?

For broad emerging markets exposure, we considered EEM, an iShares product, and VWO, a Vanguard product. We chose VWO because it has a much lower expense ratio, and has historically had better index tracking due to the fact that it holds a larger proportion of the constituents or holdings of the underlying index.

3. Is ETF selection and portfolio construction something the individual investor can effectively do on their own, or given the complexities and the dynamic nature of this market, do you think it's best left to a professional?

It depends on (1) how complex the portfolio is and (2) how diligent and disciplined the individual investor is in terms of managing the asset allocation to minimize the damage from bear markets and overvalued asset classes. One thing is certain: you don’t need to own a lot of ETFs to have a robust and diversified portfolio. It is often the case that less is more when it comes to the number of ETFs to use in portfolio construction.

4. Where do you get your news and views on ETFs? Are there particular sites or resources that are indispensable in your ETF selection and reference process?

Our favorite resources are Index Universe, Seeking Alpha, Morningstar, and the websites of the ETF managers.

5. What are your thoughts on the relatively new actively managed ETFs? If an investor is interested in purchasing an actively managed ETF, what are the important elements to look for?

The only active ETF we have used to date is MINT, PIMCO’s ETF alternative to low-yielding money market funds. We have not been interested in any of the active ETFs that have come to market. Our focus is on tactical asset allocation, using ETFs as low-cost and transparent tools for asset class exposure.