Archive for the ‘ETF News’ Category

How Can ETF’s Be So Cheap – Too Good To Be True?

By: Pete | Date posted: 09.26.2012 (1:43 am)

Last week, I received an email about reduced fees for the Charles Schwab ETF’s. Not much news about that as it seems like all issuers are gradually reducing those. What did catch my attention though is how low they’re taking their fees to. For example, both their US Broad market and US Large-Cap ETF’s will now carry a 0.04% annual MER. Yes, you read that right. That is about as close as you can get from 0. Just take a look at the fees they will be charging on their ETF’s:

U.S. Broad Market 0.04%
U.S. Large-Cap 0.04%
U.S. Large-Cap Growth 0.07%
U.S. Large-Cap Value 0.07%
U.S. Dividend Equity 0.07%
U.S. Mid-Cap 0.07%
U.S. Small Cap 0.10%
U.S. REIT 0.07%
International Equity 0.09%
Emerging Markets Equity 0.15%
International Small-Cap Equity 0.20%
U.S. Aggregate Bond 0.05%
Short-Term U.S. Treasury 0.08%
Intermediate-Term U.S. Treasury 0.10%
U.S. TIPS .07%

Too Good To Be True?

I’m the first one to say that when it seems too good to be true, it usually is, especially when it related to finance and the markets in general. That being said, this is one case where it’s not. First off, I’d like to state that while those rates are the cheapest on the market, many others such as Vanguard are awfully close and offer several ETF’s at less than 0.10% per year. Schwabb did take it one step further than anyone else had done in an attempt to gain market share.

How Is It Even Possible To Offer Such Rates?

I was asked by a good friend of mine how it was even possible to offer such rates. Are they losing money? Let’s take what I know to be an extreme example:

SPY is the largest US ETF and charges 0.095% per year. With its current assets of $120B or so, that amounts to about:


Yes, you read that right. They then need some staff to do marketing, accounting, trades, etc. Let me tell you, it is a hugely profitable fund. In fact, it could be many many times smaller and still be worth it. If you’re trying to understand, just think about the following:

How many mutual funds have a fund that more or less tracks the S&P500? Start by thinking about banks, brokers, insurance companies and all of those other ones that all have their own fund. You’d get to thousands of different ones. Then, take those funds and start moving them into a couple of dozen (maybe a bit more) huge ETF’s. You will see how the economies of scale become very important. That is also why the only thing keeping the mutual fund industry alive is the fact that most investors don’t know how much they’re paying for them or can’t/won’t look for better alternatives.

I’m not sure if it can get much lower but I would argue that fees will continue to decline in the ETF space as was the case for trading commissions in the past decade. It won’t get to 0% but we’re getting closer and closer aren’t we?

With all of that in mind, which smart investor would ever pay 2-3% again for a standard passive fund?

Are High Yield ETF’s The Latest Trend?

By: Pete | Date posted: 04.21.2012 (11:52 am)

It goes through phases. At one point, the hot commodity were those leveraged ETF’s that gave extreme volatility and amazing performances in trending markets. Then, other products such as bond ETF‘s took off, for good reason. These days, with a lot of investors nervous following the big 2008 shock, income products such as covered call etf’s, dividend etf’s and preferred shares ETF have all been very big with investors.

High Yield Bonds Take Off In The Form Of ETF’s

Buying high yield bonds is an tremely difficult transaction. They are usually very illiquid, the pricing is very difficult to determine and you usually need to buy a few million dollars of bonds per transaction. Not exactly the best product for retail. For that reason, launching high yield bond ETF’s seemed like a great idea. Why? I sometimes feel like investors buying such ETF’s are only looking at the dividend yield (which results from the high interest payments that the underlying bonds pay out).

It’s Not Free Money

I think it’s important to always remember that no financial product is “perfect”. A bond or bond ETF that is able to pay out 2%, or sometimes a lot more than a traditional bond ETF has some downside that the other does not have. In this case, it’s the risk of default. The reason these companies are willing to pay such high interest payments is because they can’t get better rates elsewhere. That means that to an extent, they are distressed. If the economy starts to suffer again or that different things occur, a few of these bonds could default.

Don’t Forget The 2008 Lessons

Subprime loans were being bought by investors who figured that buying a large pool of loans was not very risky. At most, only a few of them would go bad. In fact, it turns out that on many of these products, a large portion of those loans did go bad. The same could certainly happen to high yield bonds. I don’t think that any product should be considered based off its yield alone.

That Being Said

I do still think that high yield bond ETF’s are good products and while they might be a bit overbought, they can represent a portion of many ETF portfolios. Here are a few examples that you can look into:

HYG-iShares iBoxx $ High Yield Corporate Bond Fund
JNK -SPDR Barclays Capital High Yield Bond ETF
PHB-PowerShares High Yield Corporate Bond Portfolio 

Why Switching 401K Investments From Mutual Funds To ETF’s Makes Sense

By: Pete | Date posted: 04.07.2012 (3:34 am)

Increasingly, companies are encouraging their employees to hold ETF investments instead of the more traditional mutual funds. Why? In the end, the much lower fees make up a very large difference, especially over very long periods of time.  I was reading yesterday about the fact that Apple (AAPL) is one company that has now made the switch to ETF’s for its employees 401K’s in an attempt to save them 1% per year or so. Wondering how much of a difference 1% can end up making? Let’s consider the case of an employee that has $1000 per month saved, making a 7% return. One of them has mutual funds that charge on average 1.25% per year while the ETF employee pays an average fee of 0.20%. Take a look at the differences over 5, 10, 20 and even more years. For simplicity’s sake, the investment is made at the end of the year, as one $12,000 investment.

ETF Investor

YearStartFees (0.20%/year)ReturnInvestmentTotal

Mutual Fund Investor

YearStartFees (1.25%/year)ReturnInvestmentTotal
0$-$-$- $12,000.00 $12,000.00
1 $12,000.00 $150.00$840.00 $12,000.00 $24,690.00
2 $24,690.00 $308.63 $1,728.30 $12,000.00 $38,109.68
3 $38,109.68 $476.37 $2,667.68 $12,000.00 $52,300.98
4 $52,300.98 $653.76 $3,661.07 $12,000.00 $67,308.29
5 $67,308.29 $841.35 $4,711.58 $12,000.00 $83,178.51
10 $156,324.77 $1,954.06 $10,942.73 $12,000.00 $177,313.44
20 $429,745.57 $5,371.82 $30,082.19 $12,000.00 $466,455.94
30 $907,973.92 $11,349.67 $63,558.17 $12,000.00 $972,182.42
40 $1,744,422.17 $21,805.28 $122,109.55 $12,000.00 $1,856,726.45

And the chart that says it all….

I keep saying how big of a difference a 1% reduction in fees can make. This chart tells it all. You can diminish the numbers, change them, etc. The point is that over time, those fees do compound and end up making a huge difference.  It is not always warranted but I would say that for most people, investing in long term, passive ETF’s is a great and very simple way to do it.

Who Isn’t Switching?

My big question here would be who is not making this move and why not? I would love to hear the reasons. Simply being lazy? Having good “relationships” with those selling the mutual funds? What else?

Leveraged ETF’s Running Away From The Spotlight

By: Pete | Date posted: 04.02.2012 (12:39 am)

You might have heard about the entire TVIX fiasco. If not, I could recommend many different good readings but here is the short story. Leveraged and structured ETF’s and ETN’s have different characteristics and for that reason, some rare events can sometimes occur in those ETF’s. One important thing to understand about ETF’s is that the basic premise of the efficiency of the ETF markets mostly on one critical element:

-Having select market participants that ensure the ETF trades close to its actual value (NAV-Net Asset Value) at all times

How Do They Get It Done?

It’s quite simple. These market makers or arbitrageurs, buy or sell the ETF each time it moves away from its actual value. For most ETF’s, if it gets anywhere outside of it of 1 penny, arbitrage is made and the ETF gets back in line. There are some exceptions though. Generally, those are caused by ETF’s that are difficult to hedge. For example, an ETF that tracks high yield bonds is much more difficult to hedge than one that tracks the 30 stocks from the Dow Jones Index. This can cause the price of an ETF to be a few cents away from the NAV at certain times.

An Extreme Example

What happened with TVIX was a much more tricky situation though because the fund decided to no longer accept new creation orders. What does this mean? If someone wants to arbitrage, he needs to be able to both buy and sell units at their actual value (NAV) from the ETF issuer. Once that is no longer possible, the arbitrage opportunity becomes impossible. How can someone sell an ETF that he can only buy back in the market (which might no longer be trading close to NAV)?

Exceptional Situation

The reason why a fund would stop subscriptions or redemption can vary and they are often very complex. The most important thing to remember though is that this would happen in leveraged/structure ETF’s, and once it does, it can create nightmares. What am I talking about? Look at how the ETF prices started to move away from what they were actually worth:

This means that when the ETF does actually move back to NAV (when fund subscriptions are resumed), some investors end up losing a lot of money.

The problem is that an event like this raises a lot of concerns from regulatory arms, not only for leveraged ETF’s but ETF’s in general. It’s CRITICAL to see the difference between the 2. I can’t imagine this happening to a standard ETF while it’s likely to happen a lot more with leverage ETF’s…

The Lesson

Like any other type of financial product, it’s important to look at what you are buying carefully. Not all ETF’s are alike and not all of them are suitable for longer term investments.

Should You Buy The S&P500 Or Include More Large Caps?

By: Pete | Date posted: 03.30.2012 (2:25 am)

For good reason, many investors end up wanting to get exposure to the US equity markets. It is after all the largest market around the world by far and no matter where you are (especially for Americans), holding a good portion of those assets in US stocks seems like a very reasonable idea.

The Part I Don’t Understand

A majority of those investors end up buying ETF’s which is obviously a great way to get exposure but they very often end up buying ETF’s that track the S&P500. Why that index? There are several others right? The Down Jones Industrial Average, the Nasdaq-100, the S&P500, the Russell indexes, etc. So why do most investors end up going for the S&P500?

Is it because there are more alternatives? You can easily see 5 or 6 ETF’s that track that index with minimal fees or tracking error. However, I think that comes down to the Chicken vs. Egg debate. I would argue that those fudns are there because there was demand. Besides, there are also very good alternatives for those wanting to buy into the other indexes such as QQQ for the Nasdaq, DIA for the Dow Jones, etc.

Seems Illogical To Only Go For The S&P500

If you compare an index ETF like VTI, which invests in 3000 of the largest US stocks, rather than the 500 stocks in the S&P500, here is what you get:

-Smaller firms that will be the large caps of tomorrow
-More dynamic firms
-A better representation of the US economy (small caps have been able to generate a large part of the growth in the past century)

In the end, I would expect an index that has small cap firms to outperform in a case like this. I did compare the returns of two big US ETF’s,

SPY (S&P500)
IWM (Russell 2000)

And not a big surprise to see that IWM has outperformed SPY in the past 5 years, by over 2%! That is very significant!

So Why Would Investors Not Use These Alternative Funds More?

I think a big part of the problem is that the S&P500 has been able to become very popular and its return is usually the first one to be discussed in the media. That has certainly contributed to making investors aware of the index as the one to track, the one to beat. Sometimes, that is enough to do the trick. How often did you hear about broader indexes such as the Russell 2000 or Russell 3000 indexes in the tv, media etc? I would imagine it’s very rare. Even the very deficient Dow Jones Industrial Average seems to be able to generate more interest despite all of its flaws.

What would you be buying the next time you are looking for exposure to US equity markets? If it’s not a braod large and small cap index, why?

Will Mutual Funds Disappear?

By: Pete | Date posted: 03.21.2012 (12:42 am)

I think it’s a fair question to ask. A lot of different people have called the end of mutual funds and clearly, the momentum is clearly much greater for ETF’s. Why? Many posts describe the advantages of ETF’s over mutual funds, the biggest being lower fees of course. Added flexibility is also a big part of it. Funds want to have the ability to get in and out of trades during the day, to actively trade them, etc.

ETF’s > Mutual Funds

In almost all cases, ETF’s turn out to be much better than mutual funds. Personally, the only case I can see where it’s not the case is when an investor doesn’t have enough money to buy ETF’s (given the impact of commissions) and wants to invest in the meantime. In such a case, investing for a few months in a mutual fund can turn out to be a good proposition. It is important to make sure that there are no additional fees for early exits though because those could erase all gains made.

That being said, in almost all other cases, it is much better to buy an ETF. While the average mutual fund charges north of 1% of annual fees, most ETF’s now trade a fraction of that (under 0.20% for many big ETF’s).

Another big point is that ETF’s give us much more flexibility in how we reinvest dividends, change the asset allocation, etc. It makes it possible to also change allocations of certain sectors over time, etc.

Mutual Funds Are NOT Doomed

I think that over time, ETF’s will catch up to mutual funds in terms of assets under management but that does not mean mutual funds will end up dying. I think 2 big reasons why mutual funds will remain an important part of asset management are:

Payment structure: the fact that brokers that buy mutual funds for their clients receive a commission that is recurring every year becomes a major incentive for them to buy mutual funds even thouggh it might not be the best product for the client. It’s not fair but until the government makes it mandator for brokers to buy the best product for its clients (which would be next to impossible to enforce), I can’t see it happening. Some higher net worth clients are able to get brokers for a fixed fee which gives them an incentive to work on the highest possible returns but only the richest of us can afford to get such a broker.

Reduced Fees: This has already started. Mutual fund companies will continue to be forced into reducing their fees in order to make them competitive with the MER’s charged by ETF’s. This process will take a lot of time but I do believe it will end up happening which will be a great thing. The margins that the mutual fund companies can make on these fees remain very high so they will be able to reduce those fees when they will feel like they have no other alternative.

That being said, don’t expect me to recommend mutual funds anytime soon.

Target Date Funds/ETF’s, Good Products, But For Who?

By: Pete | Date posted: 03.17.2012 (1:49 am)

Target date funds are nothing new. Long before ETF’s came into the market, several mutual funds already offered these types of products. What is a target date fund? It is meant to be a one stop solution for investors. Basically, an investor that is expected to retire in 2020 would buy a target date fund with a “2020 target”. The objective here is to provide an easy solution for investors that fit a specific profile.

In this case, investors that are expected to retire in 2020 would want to have a riskier profile than investors retiring in 2015 but less so than in 2025.

How Are Target Date Funds Managed?

In general, most of these funds simply hold other funds. They would usually own other funds such as “Domestic Stocks”, “International stocks”, “Emerging Markets stocks”, they would also own bond funds and sometimes a few others (alternative classes, commodities, etc).

So for example, a 2020 fund could own

-20% domestic stocks
-10% international stocks
-10% emerging market stocks
-30% government bonds
-30% corporate bonds

While a 2030 fund would own:

-35% domestic stocks
-20% international stocks
-20% emerging market stocks
-10% government bonds
-15% corporate bonds

As the years go by, these funds would gradually become safer and less volatile. Seems like a win-win for everyone involved right? Let’s take a look at the main actors involved:

ETF Issuers

Clearly, fund companies that issue these funds have a lot to gain by selling these funds. Why?


-Clients holdings these hold them for longer periods of time (very profitable)
-These funds have higher fees than most standard funds
-This helps the issuers increase the assets for their sub-funds





-Many of the buyers of target date funds are employers, it’s a simple decision that is easier and less costly to do
-Requires basically no time to manage
-Provides great diversification and decent asset allocation


-The thought that all investors of a given age should have the same asset allocation is crazy, these funds are built for the “average investor” but who is “average”?
-These funds cost more to the holders than would a strategy used with 5-6 ETF’s that would usually generate a similar result

So what are your thoughts on target date funds? I think they clearly have their place in today’s marketplace but they should be mostly used by investors who do not want to or have the ability to manage their selves or who have less assets.

Why So Many ETF’s Are Being Launched

By: Pete | Date posted: 02.11.2012 (8:00 pm)

One common question for ETF investors is why there are so many new ETF’s hitting the market. Just take a look and you will see that despite that despite the fact that there are over 1400 ETF’s already trading on US markets, almost every day sees new ones hit the markets. As I write this post, I see over 20 new ETF’s that started trading in the first 10 days of February alone. What types of ETF’s?

Race To Be First

In the ETF space, it certainly seems as though the first to land a product gains a major advantage. Look at almost any type of ETF and you will see that the bigger fund is usually the oldest one as well. There are over 10 ETF’s that track the S&P500 but the biggest one (by very far) is SPY which was the first one created. There are multitudes of examples like that. There are exceptions of course like EEM which is no longer the biggest emerging markets ETF. But that took many years and a competing ETF that charged less than half of the fees to get there (VWO). As you can imagine, issuers are very much in the battle to gain assets. Why? Bigger ETF’s are more assets under management end up meaning:

-More revenues
-Economies of scale
-More brand recognition

It’s a no-brainer so you can imagine that ETF issuers are doing their best to launch the first of each type of ETF. But after 1400 ETF launches, what categories could possibly not be covered? It seems like these days issuers are looking into sub niches. For example, iShares already had many country ETF’s such as Canada (EWC) and others but it just recently launched a small cap Canadian ETF (EWCS). Another example is iShares launching EEMA (Emerging Markets Asia) as a sub-ETF to EEM (Emerging Markets). Clearly, many of these ETF’s are trading products much more than buy and hold ones. I personally believe that a good long term retirement portfolio should hold a maximum of 10-15 ETF’s or so….

Easy To Get Distracted

The overall theme is that while it’s tempting to start looking into adding dozens of new ETF’s and begin trading actively, the long term success of a retirement portfolio requires a much more passive approach.