An Analysis of Differences in Total Market ETFs
Exchange-traded funds are one of the most useful tools in creating a low-cost and low-maintenance portfolio. Due to this, the ETF industry has seen tremendous growth in assets under management, with an organic growth rate in 2013 that was approximately four times larger than that of mutual funds. As seen in the previous link, ETF market share is very concentrated with the fund families of iShares, State Street, and Vanguard holding a sizable lead in assets. Of these three, Vanguard has continued to grow the fastest by competing primarily on cost while the others in the Top 10 have seen large year-over-year growth rates due to comparatively small starting asset levels.
Within the scope of asset allocation in an investment portfolio, "total market" ETFs offer the widest sampling of a country's or group of countries' equity markets. Total market ETFs add diversification across both growth and value styles, as well as exposure to both large and small capitalization stocks. Additionally, a single international total market ETF offers geographic exposure to dozens of developed or emerging economies. However, there are drastic differences between total market ETFs of similar styles but from different issuers.
While this problem is not encountered by ETFs like Vanguard's S&P 500 ETF (NYSEARCA:VOO) or iShares' Core S&P 500 ETF (NYSEARCA:IVV) that track a strictly standardized index such as the S&P 500, total market indexes can differ greatly depending on what benchmark index the ETF issuer uses. Since many different index providers exist (examples include CRSP, Dow Jones, FTSE, MSCI, S&P) investors should be knowledgeable about what index their investment tracks. As the ETF industry has grown, there has been more competition among the index providers, and some ETF issuers have even changed benchmarks in order to reduce costs.
Investors need to be aware of these differences, as they are significant enough to have a measurable impact on a portfolio's diversification or performance given a long-term investment horizon. This article will examine and compare the ETF offerings from iShares, Vanguard, and Schwab in four different total market categories. The categories are total domestic market, total international developed market, total international emerging market and domestic real estate. Together, an ETF holding in each of these styles could be used to create a simple but well diversified equity portfolio. iShares and Vanguard were selected due to their market leading size, while Schwab was included since their ETFs have industry-leading low expense ratios. Information was taken from the ETF prospectuses on the issuers' websites and from Morningstar.
The three domestic total market ETFs are iShares' Core S&P Total U.S. Stock Market ETF (NYSEARCA:ITOT), Vanguard's Total Stock Market ETF (NYSEARCA:VTI), and Schwab's U.S. Broad Market ETF (NYSEARCA:SCHB).
Core S&P Total U.S. Stock Market ETF
S&P 500, Midcap 400, Small Cap 600
Total Stock Market ETF
CRSP U.S. Total Market Index
U.S. Broad Market ETF
Dow Jones U.S. Broad Stock Market Index
Among these ETFs, the Vanguard Total Stock Market ETF stands out as its 3644 stock holdings offer a much more complete representation of U.S. equity markets when compared to the other two ETFs. This is driven by the selection of the CRSP U.S. Total Market Index as the benchmark instead of the corresponding S&P or Dow Jones indexes. There is not much difference in expense ratio or dividend yield.
International Developed Market
The three international developed total market ETFs are iShares' MSCI EAFE ETF (NYSEARCA:EFA), Vanguard's FTSE Developed Markets ETF (NYSEARCA:VEA), and Schwab's International Equity ETF (NYSEARCA:SCHF).
MSCI EAFE ETF
MSCI EAFE Index
FTSE Developed Markets ETF
FTSE Developed ex-North America Index
International Equity ETF
FTSE Developed ex-U.S. Index
Here, the Schwab International Equity ETF offers the lowest expense ratio, and is also the only ETF with exposure to Canadian equities. However, it does have the lowest dividend yield. Both the iShares and Vanguard ETF offerings track a benchmark index that does not include any North American stocks, eliminating exposure to Canada. The iShares MSCI EAFE ETF also has a drastically higher expense ratio than either of its competitors.
International Emerging Market
The three international emerging total market ETFs are iShares' MSCI Emerging Markets ETF (NYSEARCA:EEM), Vanguard's FTSE Emerging Markets ETF (NYSEARCA:VWO), and Schwab's Emerging Markets Equity ETF (NYSEARCA:SCHE).
MSCI Emerging Markets ETF
MSCI Emerging Markets Index
FTSE Emerging Markets ETF
FTSE Emerging Index
Emerging Markets Equity ETF
FTSE Emerging Index
Among these ETFs, the Vanguard FTSE Emerging Markets ETF stands out as it offers a low expense ratio, the highest dividend yield, and the most diversification with exposure to nearly 300 more stocks than the Schwab Emerging Markets Equity ETF . I was not able to find any information on why the Vanguard and Schwab products both claim to track the same index, but differ so much with respect to number of stock holdings. Once again, an examination of alternatives to the iShares MSCI Emerging Markets ETF reveals competitors with much lower expense ratios.
Domestic Real Estate Market
U.S. Real Estate ETF
subset of Dow Jones U.S. Financials Index
REIT Index ETF
MSCI U.S. REIT Index
U.S. REIT ETF
Dow Jones U.S. Select REIT Index
Once again, the iShares ETF had a much higher expense ratio. Between the Vanguard and Schwab offerings, the difference in dividend yield is very notable as the Vanguard REIT Index ETF offers a yield that is 67% higher than the Schwab U.S. REIT ETF . This is most important for investors that are holding these ETFs in a taxable account, which is not advisable since REITs are generally recognized as being tax inefficient. Take two investors: Joe falls in the 10% tax bracket and Mary falls in the 35% tax bracket. Each $10,000 invested in the Vanguard REIT Index ETF results in $43.20 in taxes for Joe and $151.20 in taxes for Mary while each $10,000 invested in the Schwab U.S. REIT ETF results in only $25.90 in taxes for Joe and $90.65 in taxes for Mary. So assuming all other things equal, Joe could eliminate 18 basis points in tax expense each year by switching to the Schwab ETF while Mary could save 61 basis points in tax expense by switching. Knowing this, especially given a long-term horizon, could notably improve one's returns. On the other hand, if the investment was held in a tax-advantaged account, the Vanguard ETF might be more desirable due to its higher yield.
When investing in ETFs, it is important to understand what benchmark index that ETF seeks to track. Different ETF issuers subscribe to different benchmark providers and therefore two ETFs that have similar names might have dissimilar portfolio holdings. The above analysis shows that research into an ETF's competitors can result in a more informed decision which could potential improve portfolio performance. While this article was limited in scope to only three ETF issuers and four style categories, obvious differences are easily found. It also raises an interesting question to proponents of the indexing investment philosophy: which benchmark provider's indexes are most appropriate to an investor's unique needs, or are the differences minor enough that they should be ignored in favor of finding the lowest expense ratios?
Personally, if I were to create an equity portfolio with these four ETFs in a tax-advantaged account, I would choose the ETF in each category that had the highest number of stock holdings to gain more exposure to the smaller capitalization stocks in each market. This would mean selecting the Vanguard ETFs, although I would purchase the Schwab ETF in the developed markets category in order to gain exposure to Canadian equity markets. But most importantly, I now know that whenever I am considering adding an ETF to my portfolio, I should evaluate its competitors to see if there is a different ETF that better fits my individual needs.