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Exchange-Traded Funds
Total assets invested in exchange-traded products (ETPs), which include exchange-traded funds (ETFs) and exchange-traded notes (ETNs), was $2.3 trillion as of June 30, 2016.
To put this number in perspective, just five years ago, AUM totaled $960 billion. Yes, those numbers are correct: The dollars invested in U.S.-listed ETFs have tripled since 2011. (We include ETNs and other exchange-traded products in the umbrella term ETFs in this article unless specifically stated otherwise.)
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It’s important to remember that the amount in ETF assets changes over time due to inflows, outflows, reinvestment and price return. Since their inception, ETFs have provided investors with a valuable investment vehicle—one that combines the ability to buy and sell on an intraday basis like stocks and the professional management and pooling of investment dollars commonly associated with mutual funds.
Five Fund Families Dominate
Table 1 shows the current list of the 15 largest ETFs measured by assets under management (AUM), along with their expense ratios.
Compared to last year’s ETF Guide, the five largest fund families remained the largest as of June 2016: iShares, with a total of $872 billion in AUM; Vanguard, with $539 billion in AUM; SPDR State Street Global Advisors, $434 billion in AUM; PowerShares, $96 billion in AUM; and Schwab ETFs, $48 billion in AUM. These five fund families account for 88% of the overall assets in the U.S. ETF market.
Schwab ETFs grew their assets under management 40% year-over-year from June 2015 to June 2016, a rate roughly three times higher than the remaining top four fund families. The runner-up was Vanguard, with a 14.2% increase in AUM since last year’s ETF Guide. To put the size of Vanguard’s $66 billion increase in AUM into perspective, only three other fund families have total ETF AUM higher than the dollar amount of that increase.
Of the top 10 fund families (based on AUM), six decreased their average expense ratio since last year’s ETF Guide. Vanguard decreased its average expense ratio from 0.13% to 0.12% and WisdomTree’s average expense declined from 0.50% to 0.47%. Guggenheim Investments’ declined from 0.47% to 0.45%. ProShares’ average expense ratio declined from 0.94% to 0.91%, iShares’ ratio went from 0.38% to 0.37%, and First Trust’s declined from 0.72% to 0.71%. Vanguard’s expense ratio remains the lowest of the large fund families. Furthermore, at this year’s Morningstar Investment Conference, Vanguard CEO Bill McNabb said that the company is not finished cutting expenses. In 2015 alone, Vanguard reported lower expense ratios for 102 individual funds, including 28 ETFs.
In order to compete with Vanguard, Fidelity Investments lowered expense ratios on 27 index mutual funds effective July 1, 2016. Fidelity also cut the expense ratios of 11 sector ETFs from 0.12% to 0.08%, below Vanguard’s offerings.
| ETF Name (Ticker) | Total Assets ($ Mil) | Expense Ratio (%) |
| SPDR S&P 500 ETF (SPY) | 178,790 | 0.09 |
iShares Core S&P 500  (IVV) |
72,836 | 0.07 |
| Vanguard Total Stock Market ETF (VTI) | 60,529 | 0.05 |
| iShares MSCI EAFE (EFA) | 56,982 | 0.33 |
| Vanguard 500 ETF (VOO) | 46,581 | 0.05 |
| SPDR Gold Shares (GLD) | 40,330 | 0.40 |
| iShares Core US Aggregate Bond (AGG) | 38,769 | 0.08 |
| Vanguard FTSE Emerging Markets ETF (VWO) | 37,874 | 0.15 |
| PowerShares QQQ ETF (QQQ) | 34,587 | 0.20 |
| Vanguard REIT ETF (VNQ) | 34,379 | 0.12 |
| Vanguard FTSE Developed Markets ETF (VEA) | 33,041 | 0.09 |
| Vanguard Total Bond Market ETF (BND) | 31,604 | 0.06 |
| iShares iBoxx $ Invst Grade Corp Bd (LQD) | 29,418 | 0.15 |
| iShares Russell 1000 Growth (IWF) | 29,330 | 0.20 |
| iShares Russell 1000 Value (IWD) | 28,551 | 0.20 |
| Source: Morningstar, Inc. Data as of June 30, 2016. | ||
Changes to ETF Types
Vanguard, and other fund families that offer passive investments, are benefiting from a growing concern among investors that active managers can’t beat the market.
ETFs have historically been synonymous with passive management, but that is changing. ETFs can also be “active,” although the number of active ETFs remains low. As of the end of June 2016, only 156 U.S. ETFs are actively managed, while 1,771 are passively managed.
This past February, Eaton Vance launched its first exchange-traded managed fund (ETMF). This new hybrid product can be traded intraday, like a traditional ETF, but its underlying net asset value is only adjusted at the end of the day, as is the case with mutual funds. The product is intended to give active managers an ETF-like fund without having to fully disclose their holdings on a daily basis. Because the first ETMF, Eaton Vance Stock NextShares (EVSTC), wasn’t launched until this year, the funds are only included in the online version of our ETF Guide. See Charles Rotblut’s “Why Aren’t There More Active ETFs?” in the October 2015 edition of the AAII Journal for more on the ETMF concept.
Also new in this year’s Guide, we are labeling the ETFs by their legal structure. Types of structure include uncollateralized debt instruments, unit investment trusts, partnerships, open-ended investment companies, grantor trusts and collateralized debt instruments. See below for the definitions. These distinctions are more specific than what had been used in previous Guides.
Proposed SEC Rule Regarding Leveraged ETFs
In December 2015, the Securities and Exchange Commission (SEC) proposed a new rule designed to enhance the regulation of the use of derivatives by registered investment companies, including mutual funds, ETFs and closed-end funds (CEFs), as well as require firms to introduce risk management procedures.
On May 20, 2016, SEC chairman Mary Jo White said that the agency is moving forward with the proposed regulations and will make a final decision on the rule this year. The regulations are in response to the growth in the volume and complexity of derivatives over the past two decades, according to White.
In particular, the proposed regulations would have an impact on triple leveraged ETFs and triple inverse leveraged ETFs. The SEC’s proposed rule suggests that “3x ETFs” may be “unduly speculative” and clash with the regulations in place that limit how much funds can borrow to finance investments. If the rule is enacted, it would cap a fund’s (mutual fund, ETF and CEF) use of leverage (created by the use of derivatives) to 150% of, or 1.5 times, its net assets.
Roughly two-thirds of Direxion’s 76 ETFs seek to triple the daily return, or inverse return, on a market. Only 15 of ProShare’s 151 ETFs are triple leveraged or triple inverse leveraged.
New in This Year’s Guide
This year’s print guide contains 473 funds. The expanded spreadsheet contains 1,927 ETFs. (Last year, there were 1,752 ETFs and ETNs in existence.)
The categories are unchanged from last year and largely match those used in our Mutual Fund Guide. There are no new developments to justify altering the categories previously used. However, three of the 56 categories do not appear here because of the size restriction for our print version; no ETFs had over $400 million in assets in the long-short, contra commodities and foreign contra stock categories.
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, decide 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. (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, which discusses the new Level3 Passive Portfolio, is here. 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 a desired asset class and category are determined, use this guide to help 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, a large company such as Apple Inc. (AAPL) has a far larger weighting in the iShares Core S&P 500 Index ETF (IVV), which weights stocks by capitalization, 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. Pay particular 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 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 of the ETF Guide largely have at least $400 million in total assets. 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. PowerShares Russell 1000 Equal Weight (EQAL) appears here due to its inclusion in AAII chairman James Cloonan’s upcoming book “Investing at Level3” and the Level3 Passive Portfolio.
Funds included in the print version of the guide must be in existence for at least six months. The time requirement is used in the print version 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 at www.aaii.com/etf-guide. The expanded downloadable spreadsheet includes funds of all sizes and covers all 1,927 ETFs and ETNs.
Ultra and Contra ETFs
For members following aggressive trading strategies, ultra market (long) and contra 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 net asset value (NAV) return differs from the underlying index’s return. (Tracking error can also occur if an ETF’s market return is different from its NAV return. All index funds face tracking error to some extent.) Tracking error 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 ETF Guide is provided by Morningstar Inc. or is 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 averages may be skewed by ETFs only included in the online version of this guide.
The following provides an explanation of the terms we use in Table 2. The explanations are listed in the order in which the data and information appear in the guide.
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.
Structure: The letters “OE” indicate that the ETF is an open-ended investment company. “OE” includes exchange-traded funds, ETMFs and mirror open-ended funds as they report NAV returns.
The letters “DU” stand for uncollateralized debt instrument, which is an exchange-traded note. As a debt security, ETNs do not generate the return of their index via underlying securities, but the ETN issuer guarantees the holder the return of the underlying index (minus expenses).
The letters “DC” stand for collateralized debt instrument, which is also known as an exchange-traded commodity (ETC). ETCs can either track an index or a spot price, or physically hold the commodity. Like ETNs, they typically do not have portfolios.
The letters “UT” stand for unit investment trust. A unit investment trust (UIT) is a registered investment company that buys and holds a generally fixed portfolio of stocks, bonds, or other securities. “Units” in the trust are sold to investors (unitholders) who receive a share of principal and dividends (or interest). A UIT has a stated date for termination that varies according to the investments held in its portfolio.
The letter “P” stands for partnership. ETFs as partnerships are a commodity pool structure and track oil, commodities or currencies.
The letters “GT” stand for grantor trust. Indicated in the taxation portion of the prospectus, the trust will consist of a set “basket” and they have fixed portfolios.
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, 2016. 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 total return in the most recent bull market, starting March 1, 2009, and continuing through June 30, 2016. 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 total return 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 2.0% tax-cost ratio, it means that on average each year, investors lost 2.0% 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 (AUM). 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, 2016.
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: 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.
Category Definitions: Click here to download descriptions of the ETF categories used in this guide.
More on ETFs
An Inside Look at Exchange-Traded Funds
ETFs and ETNs: Knowing What You Own
Active Funds and Other Changes in the ETF Industry
Using ETFs in a Tough, Sideways-to-Bear Market
Building & Managing Your Portfolio
How to Safely Navigate Through Crowded ETF Waters
The EZ Approach to ETF Portfolio Building
Nine Timeless Rules for Investing in Mutual Funds (and ETFs)
Further Research on ETFs
Visit Computerized Investing’s “Best of the Web” sections on ETFs:
Best Sites for Mutual Fund & ETF Data
Best Sites for Mutual Fund & ETF Ratings & Recommendations
Best Sites for Mutual Fund & ETF Screeners
Choosing an ETF: Pointers to Keep in Mind
Tom Lydon of ETFtrends.com offers these tips for investors when investigating an ETF for purchase:
- Understand what the underlying index represents: Most ETFs follow an index, and holdings and percentage of holdings are very transparent.
- Understand the ETF’s structure: Some ETFs are securities-based, where others—such as commodities and currencies—represent futures or physically backed holdings.
- Know the costs: Some ETFs have expense ratios as low as eight basis points, while others can be 90 or 100 basis points. With more creative ETFs coming to market, don’t assume all ETFs are cost-effective.
- Understand liquidity: ETFs trade like stocks and have bid/ask spreads. Tracking volume and the spread is easy, but requires monitoring.
ETF & ETN Contact Information
Related
Exchange-Traded Funds
An Inside Look at Exchange-Traded Funds
Related
Exchange-Traded Funds
ETFs and ETNs: Knowing What You Own
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