Archives For Exchange-Traded Funds

I wanted to take a look at how well exchange-traded funds track their underlying indexes. So, I put together a spreadsheet to analyze the monthly returns of the ten iShares ETFs that track the ten sectors of the Dow Jones Total Market Index against their underlying index. I used only full-year data, which began in 2002. Then, I put together this graphic:

Of the ten ETFs, the worst at capturing the index’s return was the Dow Jones Technology Index Fund (IYZ), which captured only 91.48% of its underlying index. The average ETF captured 95.32% of its index’s return. NOTE: These returns are total returns but do not include transaction costs.

For more on tracking error, check out ETF Tracking Errors: Protect Your Returns from Investopedia.

I spent some time putting together the returns of some different asset class (LargeCap, MidCap, SmallCap, International, Emerging Markets, REIT, and Bond) Exchange-Traded Funds offered through iShares. I then took that information and ranked the performance for each year. I only used full-year returns. The earliest year for full-year returns was 2002. Not all of the ETFs were available in 2002 so I added them in the year they became available. Here are my findings in a PDF:

Next, I’ll look at the performance of the indexes vs. their growth and value sub-indexes. Stay tuned…

Here are the total returns for the 7 Twelve Portfolio through October 2010 (Click to see a larger version):

NOTES: This portfolio assumes $1,000,000 initial investment with a 5% income withdrawal on December 31, 2009 for a net investment of $950,000. The portfolio also does not include trading costs.

The Vanguard REIT Index ETF is up over 24% year-to-date and now makes up 9.49% of the total portfolio.

ETFs and Tracking Error

February 19, 2010

There was an interesting article in today’s WSJ about a recent report issued by Morgan Stanley on how the tracking error between exchange-traded funds and their prospective indexes increased last year:

Last year, 54 ETFs showed tracking errors of more than three percentage points, up from just four funds the prior year. And a handful of the 54 missed by more than 10 percentage points.

Nearly all exchange-traded funds, which are baskets of securities that trade all day like stocks, are designed to track indexes. So investors expect returns to closely mimic those of market gauges like Standard & Poor’s 500-stock index or the Barclays Capital (formerly Lehman) U.S. Aggregate Bond Index.

The article also mentions that the average tracking error for ETFs was 1.25% in 2009—over twice the .52% average in 2008.

For those of you who don’t know, tracking error is the difference in returns (both positive and negative) between an investment vehicle and the index it tracks. Sometimes the investment outperforms the index but it’s much more common for the investment to underperform due to fund expenses. The difference in performance can also come from how the ETF is set up. According to the article, if the ETF buys every stock in the index, then its trading costs can be higher. If it buys fewer stocks in order to just represent the index, then it can become more vulnerable to tracking error.

The article doesn’t mention how many ETFs were studied and I can’t find a copy of the report. If anyone finds a link to the report, please send it my way. I’d like to check it out.

Charles Schwab recently announced that they were getting into the exchange-traded funds game by introducing several new Schwab-branded ETFs. I have listed the new ETFs below, along with their expense ratio and the description as provided by Schwab. What makes these particular ETFs interesting is that they will trade commission-free to Schwab clients. Of course, free doesn’t mean that they won’t have spreads—the difference between the bid and ask price—but they won’t have the traditional brokerage commissions that are paid when buying or selling other ETFs.

The intial list is slim but I expect that new offerings will be added with time.

Domestic Equity ETFs

Schwab U.S. Broad Market ETFâ„¢ SCHB – 0.08%
Offers diversified exposure across large-, mid- and small-cap U.S. stocks. Seeks investment results that track performance, before fees and expenses, of the approximately 2,500-stock Dow Jones U.S. Broad Stock Market Index(SM).

Schwab U.S. Large-Cap ETFâ„¢ SCHX – 0.08%
Provides exposure to large-cap U.S. companies. Seeks investment results that track the performance, before fees and expenses, of the Dow Jones U.S. Large-Cap Total Stock Market Index(SM) made up of approximately the largest 750 U.S. stocks.

Schwab U.S. Large-Cap Growth ETFâ„¢* SCHG – 0.15%
Provides exposure to large-cap U.S. stocks that exhibit growth style characteristics. Seeks investment results that track the performance, before fees and expenses, of the Dow Jones U.S. Large-Cap Growth Total Stock Market Index(SM), representing approximately half of the market capitalization of stocks in the Dow Jones U.S. Large Cap Total Stock Market Index(SM).

Schwab U.S. Large-Cap Value ETFâ„¢* SCHV – 0.15%
Provides broad exposure to large-cap U.S. stocks that exhibit value style characteristics. Seeks investment results that track the performance, before fees and expenses, of the Dow Jones U.S. Large-Cap Value Total Stock Market Index(SM), representing approximately half of the market capitalization of stocks in the Dow Jones U.S. Large Cap Total Stock Market Index(SM).

Schwab U.S. Small-Cap ETFâ„¢ SCHA – 0.15%
Offers exposure to small-cap U.S. companies. Seeks investment results that track the performance, before fees and expenses, of the Dow Jones U.S. Small-Cap Total Stock Market Index(SM), made up of approximately 1,750 U.S. small cap stocks.

International Equity ETFs

Schwab International Equity ETFâ„¢ SCHF – 0.15%
Provides broad exposure to international large-and mid-cap companies in over 20 developed international markets. Seeks investment returns that track the performance, before fees and expenses, of the FTSE Developed ex U.S. Index made up of approximately 1,400 international stocks.

Schwab International Small-Cap Equity ETFâ„¢* SCHC – 0.35%
Offers diversified exposure to international small-cap companies in over 20 developed international markets and seeks investment results that track the performance, before fees and expenses, of the FTSE Developed Small Cap ex U.S. Liquid Index made up of approximately 1,800 international small cap stocks.

Schwab Emerging Markets Equity ETFâ„¢* SCHE – 0.35%
Offers diversified exposure to large- and mid-cap companies in over 20 emerging markets. The ETF seeks investment results that track the performance, before fees and expenses, of the approximately 740-stock, FTSE All Emerging Index.

It will be interesting to see if Schwab puts pressure on the competition to lower their ETF fees. It will also be interesting to see if Schwab somehow integrates these ETFs into their 401(k) offerings.

Related:

The Schwab Guide to ETFs

*Available in December

My last post got me to thinking about the mathematics involved in overcoming negative returns. In that post, I mentioned that 15 of the ETFs listed in the Wall Street Journal are down over 10% so far in 2008 (and that’s after just 3 days of trading!).

If a stock goes down 10%, it takes a return greater than 10% just to get back to the original price. To illustrate that point, take a look at this graphic:

So, if an investment goes down 10%, it takes a return of 11.11% just to get back to the original amount.

Now let’s say at the beginning of the year you were looking for a 10% return on your investment over the next year. But, on January 4th, you already found yourself down 10% on the year. What kind of return would you need to get so that you still received a 10% rate of return over the year? The answer is a whopping 22.22%!

Pretty amazing isn’t it? It will be interesting to see where some of those ETFs finish for the year.

and already 149 exchange-traded funds are down over 5%! I got this information from analyzing the exchange-traded quotes in today’s Wall Street Journal:

Although the graphic doesn’t mention it, 15 ETFs are down over 10%.

This isn’t a fun way to start off the year.