When Cheaper Is Better With ETFs
A hard and fast reality of ETFs is that in many cases, these products offer superior cost advantages when compared to mutual funds. Lower expenses have been a primary reason ETFs have evolved from an after thought to mutual fund companies to legitimate rivals.
Still, there is some debate regarding ETFs and the low fees these products often feature. Some experts believe costs should not be an investor's only consideration when evaluating ETFs. To that end, there are plenty of ETFs on the market today that are outperforming lower-priced competitors.
Another way of looking at the cost conundrum is that when investors find an ETF with the combination of lower fees and superior alpha generating capabilities when compared to rival funds, that ETF is certainly worthy of consideration. Yes, there are examples of cheaper being better.
SPDR S&P Biotech ETF (NYSE: XBI) Biotech ETFs have taken a breather over the past couple of weeks, but there is no getting around the fact that XBI and the iShares Nasdaq Biotechnology ETF (NASDAQ: IBB) have been two of the top-performing sector funds this year.
The two go about their business in different ways. For example, XBI is home to just 49 stocks compared to 117 for IBB. IBB has more than triple the assets under management that XBI has, but the latter has outpaced the former by more than 200 basis points this year. XBI is also 13 basis points cheaper (0.35 percent compared to 0.48 percent for IBB).
Financial Select Sector SPDR (NYSE: XLF) In the ETF business, much is made about Vanguard, the third-largest ETF sponsor, eventually wresting the top spot from iShares. What this flawed logic fails to take into account is that State Street Global Advisors has about $80 billion more in AUM than Vanguard. When it comes to sector funds, the arena where SSgA and Vanguard really knock heads, all of the sectors SPDRs are less expensive than the equivalent Vanguard funds.
In most cases, the Vanguard ETFs are just one basis point costlier than the SPDR funds. In the case of the Financial Select Sector SPDR and the Vanguard Financials ETF (NYSE: VFH), XLF is cheaper by five basis points. Year-to-date and over the past 30 and 90 days, XLF has also been the better performer. To be fair, there is this example...
Vanguard Small-Cap ETF (NYSE: VB) With an expense ratio of 0.13 percent, the Vanguard Small-Cap ETF is cheaper than 88 percent of comparable funds, according to Vanguard. One of those ETFs is the SPDR S&P 600 Small Cap ETF (NYSE: SLY). VB also holds nearly triple the number of stocks as SLY does. On a year-to-date basis, the Vanguard fund wins the performance battle by just over 200 basis points.
Technology Select Sector SPDR (NYSE: XLK) The Technology Select Sector SPDR is known for having one of the largest weights to Apple (NASDAQ: AAPL) of any ETF. The The iShares Dow Jones U.S. Technology Sector Index Fund (NYSE: IYW) is known for having THE largest weight to Apple of any ETF.
The Apple exposure explains why both funds have done well this year, but those investors that were willing slice their Apple allocation down a bit did better by going with XLK. XLK charges 0.18 percent per year and is up 18.8 percent year-to-date. IYW, which has an expense ratio of 0.47 percent, is up 16.6 percent.
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