Why a Cheap ETF Isn’t Always Better

ETF Trends

The exchange traded fund “fee” war has been in focus over the past year as sponsors have rallied for market share. While an expense ratio is a big consideration for investors, it should not be the deciding factor.

“In ranking equity and fixed income ETFs, S&P Capital IQ uses three cost factors to provide insight into how an ETF compares to its asset class. The gross expense ratio is supported by the aforementioned bid-ask spread and the 5-day average price-to-NAV. On the MarketScope Advisor platform, users can see these metrics as well as whether they contribute favorably or unfavorably to the overall ETF ranking,” S&P Capital wrote in a recent note.

S&P Capital hosted two panels at the recent Pershing INSITE 2013 conference in Florida titled “Promising New Strategies in the World of ETFs”. The focus of discussion was the  metrics investors should use in order to sort through the 1,000 plus choices of ETFs on the market. Ryan Issakainen of First Trust and David Mazza of State Street Global Advisors were on hand to to give additional insight.

Many ETF providers have substantially lowered the cost of owning an ETF in an effort to keep up with current industry trends. Commission-free trading platforms have also been a popular offer for various brokerage houses. Experts warn that costs should never be the only deciding factor when selecting an ETF. Stock selection and weighting within a benchmark are more important since this influences performance. For instance, an ETF could cost more than a similar fund, but may outperform the other due to sector or stock choice. This ETF will give back more than what could have been saved with a lower expense ratio due to outperformance. In fact, some ETF sponsors may use a low expense ratio as a selling point in order to gather more assets under management. [Cost Matters with ETFs: Vanguard Report]

The following ETFs have been analyzed by S&P Capital and are rated as good buys determined by the single stocks they include. These are based upon valuation and risk perspectives, not the expense ratio alone:

  • First Trust Healthcare AlphaDEX Fund (FXH)  expense ratio 0.70%
  • SPDR Russell 1000 Low Volatility ETF (LGLV)  expense ratio 0.20%
  • Health Care Select Sector SPDR (XLV)  expense ratio 0.18%
  • First Trust ISE Cloud Computing Index Fund (SKYY)  expense ratio 0.60%

The cost of owning an ETF is not a simple glance at an expense ratio. There are plenty of other factors to consider that go beyond the ETF fee war. [Cheaper 'Core' iShares ETFs off to Fast Start]

“There are other implicit transaction costs to consider. For example, investors also should assess bid/ask spreads before buying and selling shares of an ETF. As a general rule of thumb, ETFs with large asset bases and high trading volumes generally will have lower bid/ask spreads than smaller ETFs with lower trading volumes,” Timothy Strauts wrote for Morningstar. [Index Hugging Mutual fund Shamed by Cheap S&P 500 ETFs]

Tisha Guerrero contributed to this article.

 

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

Rates

View Comments (0)