Market Overview

ETF Opinion: The $100M Watermark Is Asinine

*Please note the following is the fact-based opinion of the ETF Professor. Those opinions are his own and do NOT represent the views of Benzinga. Divergent view points are appreciated and the ETF Professor welcomes such discourse. Feel free to contact him on Twitter: @ETFProfessor1

As is the case with every corner of the financial market, the ETF industry is all about numbers. Total number of funds, assets under management, volume, new fund launches, fund closures, etc. The list goes on.

To that end, it's not surprising that some folks that follow the exchange-traded products industry get fascinated with certain numbers and use those numbers as tools to evaluate a fund's success. A couple of years ago, it was an ETF's ability to attract $25 million in its first year of trading that made it a success. Or it was trading a certain average dollar amount on a daily basis or having average daily volume of X amount of shares.

The new ETF number of the moment seems to be $100 million. As in an ETF that has $100 million or more in assets under management is a "success" while anything below that should be stamped with a scarlet letter or excommunicated from the ETF universe.

The $100 million AUM thesis might stem from a McKinsey report that quantifies ETFs as successful if they're able to rake in $100 million in AUM in their first year of trading. Unfortunately, the report misses the mark because there is little to no empirical evidence to support the assertion that $100 million AUM ETFs are proficient at anything other than surviving.

So when statements such as "avoid ETF with less than $xx assets under management" or "stick with bigger ETFs because they diminish trading risk" are made, those words can lead investors to bigger, but not always better funds.

For starters, the most important measuring stick of success for any ETF is its ability to generate returns. Beyond that, there is no hard and fast definition of what makes an ETF or ETN "successful." It's not as easy as saying "Well, a Major League hitter that gets 3,000 hits is a lock for the Hall of Fame" because some ETF issuers will pull the plug on low volume, low asset funds while others will keep those funds out on the market for years and years.

Just as two examples, go to the iShares and PowerShares Web sites and within a matter of minutes you'll see that these firms, the largest and fourth-largest U.S. ETF issuers, respectively, have dozens of ETFs that have neither $100 million in AUM or respectable average daily volume. Yet because these are big issuers run by large asset management companies, they can afford to keep ETFs that some would condemn as "bad" out on the market.

What's truly dangerous is the assumption, and that's all it is, that size in terms of AUM begets success with ETFs when it has already been documented that some low asset/low volume funds offer the potential for stellar returns.

Of the top-10 ETFs in terms of performance during the first quarter, eight were plain vanilla equity-based funds. Living the $100 million AUM lifestyle would have helped investors miss out on the following: A 34% jump by the Market Vectors India Small-Cap ETF (NYSE: SCIF), an almost 34% gain for the Market Vectors Egypt Index ETF (NYSE: EGPT), a 27% surge for the RevenueShares Financial Sector Fund (NYSE: RWW) and a 26.4% climb for the Guggenheim Shipping ETF (NYSE: SEA).

The list goes on. The EGShares India Consumer ETF (NYSE: INCO) is up solidly on a year-to-date basis with nowhere near $100 million in AUM. I'm not saying it's the best fund or that it's long for the world, but the iShares MSCI Emerging Markets Financials Sector Index Fund (Nasdaq: EMFN) is up more than 16% this year and that's with less than $3.6 million in AUM. And that's from an iShares fund that is more than two years old!

The bottom line is the ETF universe has played out a like the world of equities where the biggest funds have become the ones that typically get the most attention. That's not a criticism, that's just the way things are. But another parallel can be drawn: Investors have that have been fortunate enough to find individual equities that aren't mentioned on CNBC everyday or that are widely followed by analysts have, on some occasions, been handsomely rewarded by those "hidden gems." When it comes to hidden ETF gems, the sub-$100 million AUM arena is probably the place to look. The statistics indicate as much.

Posted-In: Long Ideas News Sector ETFs Broad U.S. Equity ETFs Short Ideas Specialty ETFs New ETFs Emerging Market ETFs Best of Benzinga

 

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