Not All ETFs Are Created Equal

by: Tom Lydon

Although exchange traded funds provide an easy way to gain broad exposure to different market sectors, not all of them are created equal. ETFs that track the same sector, related indexes, and even the same index will vary in performance because of a number of different factors.

For example, let’s compare RevenueShares Financials Sector Fund (NYSEARCA:RWW) to PowerShares Dynamic Financial Sector Portfolio (NASDAQ:PFI). Both funds track the financial sector, but they differ in their index composition and methodology. RWW weights stocks by revenue rather than market value, while PFI looks at trailing stock performance amongst other factors. As a result, RWW loaded up on the banking giants while PFI invested more in regional and community banks. The result? RWW gained 97% to PFI’s 33% over the past 12 months, reports Reshma Kapadia for The Wall Street Journal.

Here are some factors to consider when choosing an ETF:

The expense ratio will have a direct impact on fund returns and vary from fund to fund. For example, Vanguard Emerging Markets ETF (NYSEARCA:VWO) charges 0.45% less than iShares MSCI Emerging Markets Index Fund (NYSEARCA:EEM). As a result, investors poured $4 billion more into VWO than EEM last year.

The fund size can have a direct impact on trading costs because volume helps keep trading costs low. For example, the $78 billion dollar SPDR S&P 500 ETF Trust (NYSEARCA:SPY) has a bid-ask spread of only one cent compared to the $23 billion iShares S&P 500 Index Fund (NYSEARCA:IVV) spread of four cents.

The capital structure affects funds in specific ways that can affect performance and risk. For example, Vanguard Total Bond Market (NASDAQ:BND) is a share class of the $68.8 billion sister bond fund, which helps offset the risk of illiquid securities. Thus, BND can invest in a broader range of bonds compared to the smaller iShares Barclays Aggregate Bond Fund (NYSEARCA:AGG) and SPDR Barclays Capital Aggregate Bond ETF (LAG). The effect can be seen in their annual returns: AGG and LAG have had annual returns that varied up to 3.2% off the market index, whereas BND has never veered more than 2.3%.

Finally, the composition of funds can also impact both performance and risk. For example, PowerShares QQQ Trust, Series 1 (QQQQ) tracks the Nasdaq 100 index of non-financial stocks while Fidelity NASDAQ Composite Index Fund ETF-Tracking NUS (NASDAQ:ONEQ) tracks almost all 2,000 stocks in the Nasdaq. Over the last five years, QQQQ’s average annual return has been 6.1% compared to ONEQ’s 4.4%. iShares FTSE/Xinhua China (NYSEARCA:FXI) is the largest China ETF, but holds only 25 of the largest and most liquid stocks in China, resulting in about half of its assets allocated to state-owned and financial stocks. Compare that to SPDR S&P China ETF (NYSEARCA:GXC) which holds 129 different stocks and provides diversification against China’s fiscal policies.

Sumin Kim contributed to this article.