The exchange-traded fund ETF industry continues to grow, and signs point to further expansion.

As of June 30, 2014, $1.86 trillion was managed by exchange-traded funds and exchange-traded notes ETNs. In contrast, a year prior, total assets under management were $1.44 trillion. In terms of the number of offerings, there are now 1,613 ETFs and ETNs versus 1,479 a year prior. (To simplify the discussion here, we use the term ETFs to encompass ETFs and ETNs.)

Even with the growth, the vast majority of investment dollars are under the control of just a handful of ETF families. Nearly one out of every two ETF dollars is placed with an iShares fund. (The iShares family is owned by BlackRock.) More impressively, iShares’ $718.4 billion assets under management AUM, as of June 30, 2014, excludes dollars invested in other exchange-traded funds that BlackRock subadvises, such as Fidelity’s. SPDR State Street Global Advisors ranks second with $402.9 billion in AUM. SPDR S&P 500 SPY, the very first exchange-traded fund and still the largest, accounts for more than 40% of SPDR State Street’s total AUM. Vanguard ranks third among the fund families with $384.0 billion in AUM. Combined, more than 80% of all ETF dollars are invested with these three fund families.

This does not mean other companies aren’t trying to steal market share. J.P. Morgan, one of the largest mutual fund companies, jumped into fray this year with its first exchange-traded fund, JPMorgan Diversified Return Global Equity JPGE. The fund, which follows a smart beta approach to weighting global equities, has had a quiet start, attracting $15.2 billion in AUM. (The median exchange-traded fund has $81.3 billion in AUM. Due to the comparatively massive size of the largest ETF, average AUM for all exchange-traded funds is a less representative number than median AUM.) Emerging Global Advisors (EGShares) and Merk Investments also entered into the ETF market. Last September, Citigroup launched its second ETN, C-Tracks, based on the performance of the Miller/Howard MLP Fundamental Index MLPC.

In early June 2014, two ETNs based on the Russell 1000 Growth index launched: Credit Suisse FI Large Cap Growth Enhanced ETN FLGE and UBS AG FI Enhanced Large Cap Growth ETN FBGX. We mention them because they both have attracted more than $500 million in AUM during their first weeks of existence. Though their size technically qualifies them for inclusion in the print version of this guide, we kept them solely in the online version (available at AAII.com) because of their lack of return data.

Smart beta strategies have been a growing topic of conversation. ETFs that use this approach are based on non-traditionally weighted indexes. Whereas broad indexes, such as the S&P 500 index, assign the largest weighting to the company with the biggest market capitalization and the lowest weighting to the company with the smallest market capitalization (called market-cap weighting), smart beta indexes weight companies differently. These indexes may weight companies equally or weight them based on fundamental or price volatility factors. Examples of funds following smart beta strategies include Guggenheim S&P 500 Equal Weight RSP, PowerShares FTSE RAFI US 1000 PRF, PowerShares S&P 500 Low Volatility SPLV and WisdomTree LargeCap Dividend DLN. In the online version of this guide, ETFs based on price momentum–weighted indexes, such as the iShares MSCI USA Momentum Factor MTUM, are also listed.

ETF Downloads

Expanded ETF Listings Spreadsheet (XLS) DOWNLOAD   Field Definitions (XLS) DOWNLOAD   All ETFs (PDF) DOWNLOAD   Download Guide (PDF) DOWNLOAD

Determining if an ETF follows a smart beta strategy or a traditional market cap–weighted index cannot always be done by simply looking at the fund’s name. Though some names are obvious, others are not. Morningstar, which provides the data for this guide, does not designate which ETFs use a smart beta strategy and which do not. This may partially be due to the fact that the definition of what constitutes a smart beta strategy seems to be evolving. For example, equal-weighted indexes are now largely considered to be smart beta strategies even though they weren’t before the smart beta moniker gained popularity. Plus, although the Dow Jones industrial average also does not use market-cap weighting, it is not considered to be a smart beta index. This is why it is important to read the literature to determine exactly what type of index an ETF is designed to follow. Even two funds with very similar-sounding names can follow different indexes.

New in This Year’s Guide

We added nine additional funds to this year’s print guide, bringing the total to 446. The online version of this guide contains a comprehensive spreadsheet of all 1,613 ETFs. (Last year, there were 1,479 ETFs and ETNs in existence.)

We also added two new categories to the print guide: long-short and contra commodities. Long-short funds follow hedge-fund like strategies and other alternative strategies. These categories are being included for the general interest.

Commonly nicknamed “alt funds,” long-short funds are primarily intended to realize a return different from traditional stock and bond investment strategies. Though the diversification argument is being used as a primary selling point by the investment industry, be aware of the limited history these funds have. Out of the 25 total ETFs grouped into the long-short category, only four were launched prior to 2010. Expense ratios are comparatively high, averaging 0.91%. In contrast, the average expense ratio for all ETFs is 0.62%. The two largest of these types of funds, PowerShares S&P 500 BuyWrite PBP and ProShares Large Cap Core Plus CSM, have $292 million and $314 million in assets under management. Several other long-short ETFs have less than $10 million in AUM, a very small amount.

One challenge with alt funds is the complexity of the strategies they follow. It is prudent to avoid any fund—be it an ETF, a mutual fund, or a hedge fund—whose strategy you do not fully understand. If the strategy is not clear to you, the risks that could cause you to lose money will not be clear either.

Two contra commodities funds are included in the print version of our guide, and 21 total are included in the online guide. As the name implies, these funds are designed to realize a return opposite to the price movement of an underlying commodity. Investors should be aware of the risks associated with these funds. Not only do they require making a correct decision on the direction of a commodity’s price, they also are subject to unexpected performance resulting from the compounding of daily returns. See the “Ultra and Contra ETFs” section in this guide for more on the implications of leveraged funds and compounded returns.

The Largest Funds

Table 1 shows the largest 15 funds ranked by total assets. This table was first published in last year’s guide and has been updated for this year’s guide. Cumulatively, $0.35 out of every dollar invested in ETFs is in the largest 15 funds. The concentration increases as total assets rise. The five largest funds control $0.20 out of every dollar invested in ETFs. Slightly less than a dime ($0.091) out every ETF dollar is controlled by the largest fund, SPDR S&P 500. Notably, the market share controlled by the largest ETFs has very modestly decreased from last year.

Table 1. The 15 Largest ETFs

ETF Name (Ticker)	Total Assets ($ Mil)
		Expense Ratio (%)
SPDR S&P 500 (SPY)	168,463	0.09
iShares Core S&P 500 (IVV)	57,762	0.07
iShares MSCI EAFE (EFA)	55,685	0.34
Vanguard Emerging Markets Stock Idx ETF (VWO)	46,456	0.15
Vanguard Total Stock Market ETF (VTI)	44,575	0.05
PowerShares QQQ (QQQ)	43,744	0.2
iShares MSCI Emerging Markets (EEM)	39,841	0.67
SPDR Gold Shares (GLD)	33,416	0.4
iShares Russell 2000 (IWM)	26,125	0.24
Vanguard REIT Index ETF (VNQ)	23,861	0.1
iShares Russell 1000 Growth (IWF)	23,854	0.2
iShares Core S&P Mid-Cap (IJH)	23,603	0.15
Vanguard FTSE Developed Markets ETF (VEA)	23,534	0.09
iShares Russell 1000 Value (IWD)	23,205	0.21
Vanguard Total Bond Market ETF (BND)	20,498	0.08
Source: Morningstar, Inc. Data as of June 30, 2014.

The only top 15 fund from 2013 not to make this year’s list is iShares iBoxx $ Investment Grade Corporate Bond LQD. This fund’s AUM declined from $19.5 billion in June 2013 to $17.8 billion this year. Taking its place is Vanguard FTSE Developed Markets VEA, with $23.5 billion in AUM (up from $13.2 billion in 2013.)

In addition to iShares iBoxx $ Investment Grade Corporate Bond, two other top 15 funds from last year experienced declines in AUM during the 12-month period ended June 30, 2014. SPDR Gold Shares GLD saw its AUM decline by $3.7 million to $33.4 billion as gold prices continued to underperform stock prices. Vanguard Emerging Markets Stock Index VWO ended June 2014 with $46.5 billion in AUM versus $49.4 billion in June 2013. We’d like to attribute this decline to the weakness experienced by emerging market stocks during the fourth quarter of last year, but iShares MSCI Emerging Markets EEM saw its AUM increase by $5.2 billion to $39.8 billion.

SPDR S&P 500 SPY enjoyed the largest dollar increase, with AUM rising $35.1 billion to $168.5 billion. Competitor iShares Core S&P 500 IVV experienced a larger percentage increase, however, with AUM rising 35.7% to $57.8 billion. The larger percentage increase may reflect the iShares ETF’s lower expense ratio compared to the SPDR ETF, 0.7% versus 0.9%, respectively.

Expense ratios were lowered on four of the largest 15 funds. Vanguard reduced the expense ratios on its Emerging Markets Stock Index, FTSE Developed Markets, and Total Bond Market BND ETFs by 0.3, 0.1 and 0.2 percentage points respectively. iShares lowered the expense ratio on its MSCI Emerging Markets fund by 0.2 percentage points.

Be Careful With Newer Funds

A total of 101 ETFs launched during the first half of this year. Nearly half of these funds invest in international equities. Within this subset are many funds using smart beta or other non-traditional strategies to target specific countries. Examples include iShares MSCI Qatar Capped QAT and WisdomTree Japan Hedged Real Estate DXJR.

The crowded ETF space has caused fund families to look for new ideas to base indexes, and thereby, funds upon. The smart beta and alternative weighting strategy trends we see among new international funds applies to most new domestic equity funds as well.

On the bond side, we notice several new funds designed for an uncertain interest rate environment. These include PIMCO Low Duration ETF LDUR and iShares Interest Rate Hedged High Yield Bond HYGH. We understand the appeal of such funds, but if the underlying strategies have not been actually used in a rising interest rate environment before, future returns may turn out to be different than investors expect.

Information on all of the funds launched this year can be found in the online version of this guide. The newest funds lacked sufficient return data for inclusion in the print guide, and most lacked enough AUM as well.

How to Use This Guide

Exchange-traded funds have lowered the cost and increased the accessibility of investing in a wide variety of securities, including large-cap stocks, emerging market debt, precious metals, currencies and even agricultural commodities. However, more choice does not necessarily equate to higher returns. Therefore, investors should tread carefully.

Financial goals, diversification needs and risk tolerances should be the primary determinants when selecting an exchange-traded fund. Specifically, ask what asset classes and categories need to be included in your portfolio and then look for ETFs that match those requirements. Asset allocation ideas can be found in the Financial Planning section of AAII.com. Our Model Fund Portfolio provides an idea of how to build and manage a diversified portfolio using a mix of mutual funds and exchange-traded funds and an alternative all-ETF portfolio. (We believe investors should compare both types of funds and use the one that provides the best exposure to a specific asset class or investment strategy.) The Model Fund Portfolio is reviewed in the March, May, August and November AAII Journal issues; the latest commentary starts here of this issue. Monthly updates are available at AAII.com and via the free monthly AAII Model Portfolios Update email (sign-up at www.aaii.com/email).

Once asset class and category are determined, use this guide to find an appropriate exchange-traded fund. Most funds are named based on their underlying index (e.g., SPDR S&P 500 tracks the performance of the S&P 500 index). Understand that the construction of the underlying index will have a significant impact on the fund’s performance. For example, Exxon Mobil Corp. XOM has a far larger weighting in iShares Core S&P 500 Index ETF than it does in Guggenheim S&P 500 Equal Weight RSP. The bigger the weighting, the greater the influence on an ETF’s performance. The column in the guide labeled “percent of portfolio in top 10 holdings” shows how much weight is allotted to a fund’s largest positions.

All ETF sponsors list current holdings and the weighting of those holdings on their websites. This information not only provides additional insight into how dependent a fund is on its top two or three holdings, but it can also help improve an investor’s portfolio diversification. Specifically, pay attention to whether a specific company accounts for a large position in two or more funds you are interested in.

Expenses matter, and lower expenses are preferable. Expenses are influenced by the underlying securities; funds that use foreign securities, invest in commodities, or use aggressive long or short strategies carry higher expenses. Some brokers waive commissions on select ETFs, but the savings on the commissions need to be weighed against the annual expense ratio and the suitability of the ETF. In other words, selecting an exchange-traded fund solely because commissions are waived may actually turn out to be a more expensive decision.

Again, be sure to look at a list of the fund’s current holdings and read through the prospectus before buying any exchange-traded fund. A listing of ETF sponsor websites is included with the online edition of this guide.

Which Funds Were Included

The funds listed in the print version largely have at least $400 million in total assets, a $150 million increase from the minimum total assets used in last year’s guide. The rule was relaxed for funds held within the Model Fund Portfolio, which is why you will see Guggenheim S&P MidCap 400 Pure Value RFV, and Guggenheim S&P SmallCap 600 Pure Value RZV in the print guide. We also relaxed the rule for categories of general interest whose funds are not large enough to have qualified for the AUM rule.

We carried over a requirement from last year that funds must be in existence for at least six months. The time requirement is used to limit the number of funds listed in the print version of this guide for space reasons, while still allowing newer funds with sizeable amounts of total assets to be included.

A comprehensive listing of ETFs and ETNs with performance data and additional information is available on AAII.com at www.aaii.com/etf-guide. The expanded downloadable spreadsheet includes funds of all sizes and covers all 1,613 ETFs and ETNs.

Ultra and Contra ETFs

For members following aggressive trading strategies, ultra market long and contra stock market are two of the categories included in this guide. The ultra category includes funds that are designed to move in the same direction as their underlying index, but to experience two to three times the price movement. The contra categories (stock, bond and commodity) contain funds that are designed to move in the opposite direction as the underlying index. Some of these funds may experience inverse price movements that are two to three times greater than those of the underlying index.

Funds that move with a greater magnitude than the index they track use leverage. For every dollar invested, an investor has the potential to earn double or triple the return he or she would otherwise earn. At the same time, the magnitude of potential losses is two to three times greater. In other words, these are very risky investments.

In addition to the considerably higher level of volatility, these funds have a much greater potential for tracking error. Tracking error is the extent to which a fund’s actual return differs from the index’s return. It can result in actual returns being significantly different from what an investor anticipated based on the performance of an index. ProShares, one of the providers of ultra and contra funds, clearly warns investors not to hold such funds for longer than one day. Specifically, ProShares states, “Due to the compounding of daily returns, ProShares’ returns over periods other than one day will likely differ in amount and possibly direction from the target return for the same period.”

This warning applies to both ultra and contra funds. These ETFs are suitable only for speculative trading for the time period listed in the prospectus (typically a single day); they should not be used for a longer-term holding.

Investors concerned about market risk will be better served by maintaining proper diversification across asset classes, staying focused on long-term financial goals and conducting a thorough analysis of all investments.

A Key to Terms and Statistics

Most of the information shown in the listing is provided by Morningstar Inc., or calculated from the data the company provided. Any data source has the potential for error, however. Before investing in any exchange-traded fund or exchange-traded note, you should read the prospectus, annual report and quarterly reports.

When a dash appears in an ETF listing, it indicates that the number was not available or does not apply in that particular instance. For example, the three-year annual return figure would not be available for funds that have been operating for less than three years. We did not compile bull and bear ratings for ETFs not operating during the entire bull or bear market period.

Return numbers that are in the top 25% of all funds within the investment category are shown in boldface. When the risk is in the lowest 25% for the category, this number is also bolded.

Figures given for the category averages are calculated based on the entire universe of ETFs.

The following provides an explanation of the terms we use in the ETF listings. The explanations are listed in the order in which the data and information appear in the listing.

Index Fund: The letter “I” before a fund’s name indicates that the fund is designed to mimic the performance of an index, such as the S&P 500; the amounts invested in each security are proportional to its representation in the index that the fund tracks. (Some funds may hold fewer securities than the actual index if they believe the same return characteristics can still be achieved.) The online version of this guide reports on the indexes tracked by these funds. In some cases, an index has been specifically created for the fund and may have different return characteristics than other indexes with similar names.

Enhanced: The letter “E” before a name indicates that the fund is designed to outperform its underlying index by improved security selection or following a strategy that reduces comparative volatility.

Exchange-Traded Note ETN: The letter “N” before a fund’s name indicates that the investment is an exchange-traded note. An ETN is a debt security designed to mimic the performance of an underlying index. The credit quality of the issuer needs to be considered when researching an ETN.

ETF Name: The exchange-traded funds are presented alphabetically by name within each category.

Ticker: The ticker symbol for each exchange-traded fund is given in parentheses for those investors who may want to access data online or through a touch-tone phone.

Total Return (%): Returns are based upon changes to a fund’s net asset value NAV or, where designated, share price (market return), assuming the reinvestment of all income and capital gains distributions (on the actual reinvestment date used by the fund) during the period. The return calculation is net of expenses. The year-to-date, 12-month, three-year and five-year returns are calculated through June 30, 2014. The three- and five-year returns are presented on an annualized basis. Returns that are in the top 25% of all ETFs within the investment category are shown in boldface.

Bull Market Return: Reflects the ETF’s net asset value performance in the most recent bull market, starting March 1, 2009, and continuing through June 30, 2014. Returns in the top 25% of all ETFs within the investment category are shown in boldface.

Bear Market Return: Reflects the ETF’s net asset value performance in the most recent bear market, from November 1, 2007, through February 28, 2009. Returns in the top 25% of all ETFs within the investment category are shown in boldface.

Yield (%): The total annual income distributed by the ETF divided by the period-ending net asset value. Calculated on a per share basis, this ratio is similar to a dividend yield and would be higher for income-oriented funds and lower for growth-oriented funds. The figure only reflects income; it is not a total return.

Tax-Cost Ratio (%): Measures how much an ETF’s annualized return is reduced by the taxes paid on distributions, assuming the maximum marginal tax rate. A tax-cost ratio of 0.0% indicates that the fund did not make any taxable distributions. If a fund had a 3.0% tax-cost ratio, it means that on average each year, investors lost 3.0% of their assets to taxes. The lower the ratio, the more tax-efficient the ETF. The ratio is calculated using the last three years of data.

Risk Index—Category and Total: The category risk index is the standard deviation of an ETF’s return divided by the standard deviation of return for the average ETF in the category. The total risk index is the standard deviation of an ETF’s return divided by the average standard deviation of return for all funds. Standard deviation is a measure of return volatility and is computed using monthly returns for the last three years. A risk index of 1.00 denotes average risk. Values above 1.00 indicate greater risk than average while values below 1.00 indicate less risk than average. Risk numbers that are in the lowest 25% of all funds within the investment category are shown in boldface.

Total Assets ($ Mil): Presented as millions of dollars, this is the amount of total assets an exchange-traded fund has under management. This is the total value of the fund’s portfolio. Size can be affected by the age of the fund, the index it follows and the number of competitive funds.

Average Daily Trading Volume (Thousands): Average daily volume of shares traded for the last three-month period through June 30, 2014.

Portfolio (%)—Stocks: The percentage of assets held in common stocks, both domestic and foreign. Bonds: The percentage of assets held in debt securities that are not convertible into common stock. Other securities: The percentage of assets held in futures, options, preferred stock, trusts or other alternative securities. Cash: The percentage of assets held in cash or cash equivalents.

Percent of Portfolio in Foreign Issues: The percentage of the ETF’s assets that are invested in foreign stocks and foreign bonds.

Portfolio Turnover Ratio (%): A measure of the trading activity of the ETF, which is computed by dividing the lesser of purchases or sales for the year by the monthly average value of the securities owned by the fund during the year. Securities with maturities of less than one year are excluded from the calculation. The result is expressed as a percentage, with 100% implying a complete turnover within one year.

Number of Holdings: The total number of individual securities held by the ETF. These can include stocks, bonds, currencies, futures contracts and option contracts. This figure is meant to be a measure of portfolio risk: The lower the number, the more concentrated the fund is in a few issues. Some ETFs may hold fewer shares than the index’s name would suggest if the ETF’s manager believes he can mimic the returns of the index without holding all of the securities in it.

Percent of Portfolio in Top 10 Holdings: Investments, expressed as a percentage of the total portfolio assets, in the ETF’s top 10 portfolio holdings. The higher the percentage, the more concentrated the fund is in a few companies or issues, and the more the fund is susceptible to market fluctuations in those few holdings. Used in combination with the number of holdings, this figure can indicate how concentrated an ETF is.

Expense Ratio (%): The sum of administrative fees and adviser management fees divided by the average net asset value of the ETF, stated as a percentage. Brokerage costs incurred by the fund are not included in the expense ratio, neither are the commissions you may pay to buy and sell shares.

Related

Exchange-Traded Funds

ETFs and ETNs: Knowing What You Own

Related

Mutual Funds

The EZ Approach to ETF Portfolio Building