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I recognize that MFO members thoughtfully discuss mutual funds, and find the discussions interesting and helpful. Even though the majority of our portfolio is invested in mutual funds, I was wondering if there has been any discussions in the past regarding the use of ETF's in portfolio's? Thanks
Well, of course there are frequent mentions of various individual ETFs, but I don't recall any extensive discussions regarding the pros & cons of either substituting an ETF for a particular fund group, or mixing ETFs and funds in any particular manner or proportion as a portfolio makeup. I also would like to see a healthy discussion of these concepts.
I don't at this time use etfs within my portfolio. I feel etfs are designed to be traded and mutual funds are designed for investing. I just did not want to go the trading route. I have no problem with funds that I hold that use etfs as an aid in the deployment of their strategies. Again, form my thoughts etfs are designed to be traded.
Good point, Skeeter. Maybe that's the reason for the lack of response. I don't use them either, and I've long wondered if I was overlooking something important. Seems to me that some old hands, like Ted (if I remember correctly) do use them, and tend to keep them for a long time, rather than trading. I'm not interested in rapid trading, of anything.
Since no one else has in this thread given pros and cons I will try Mutual funds may be best if you are doing periodic investing like dollar cost averaging but because online commisions are so low this days and ETF expense ratios are generally low lump sum investments may often result in lower expenses for ETFs.
It may be easier to do dividend reinvestment in funds
ETFs are very good for making a country or sector overweighting. For example If I believe that Egypt will come out of the current mess very well and prosper an investment in Egyptian stocks may look like a good idea and An ETF is the way to do that. The last sentence should NOT be interpreted as a suggestion to buy Egyptian stocks. I have no idea how well that would work out
In taxable accounts most ETFs are more tax friendly than most fund for reasons not easy to explain in a sentence though two paragraphs might not be needed. In some cases its easier to find a "pure" investment For example If you had a crystal ball in 2008 and KNEW the best investment would be long term treasuries but corporate bonds would not do as well you might have to read a variety of prospectuses to find the right fund but finding the right ETF would have been less difficult.
I held BOND for a while...until it crossed 200 day moving average, then out I went.
Should have done same with AQRIX, but I was too dumb.
From the board, I've learned that when trading ETFs, be wary of volume, since Price and NAV can be quite different on lower volume offerings. So, be sure to look for more highly traded ones.
ETFs tend to be more index oriented, either to particular markets or sectors.
I personally favor active managers that have gained my trust (as misguided as that may be), so I generally hold no-load, open ended funds. Or, individual stocks.
Currently, no ETF holdings. I do think M* does good job of describing particular ETF pro-and-cons, if you subscribe to their premium service.
There are broad market indices that can be used to construct portfolios if you are into passive index investing. Folks at Bogleheads use these. You don't hear much about these here as most people here are playing the active management game and they are not exciting.
Then there are those ETFs that are designed for traders or gimmicky, expensive.
First, let's separate the broad based index ETFs from the leveraged, inverse, niche (the late, unlamented HealthShares come to mind). As Investor wrote, all but the first are at best, designed for traders.
I meet John Bogle half way in my view of ETFs. Many are a lot of hype, encourage trading, and are not economical, either from an ER perspective, or from a tax perspective. (I'm largely echoing Investor's comment here).
The broad based index ETFs do mostly live up to their descriptions. They are indeed tax efficient (so long as they are market cap/free float based, or otherwise designed with buffers to reduce turnover). But so are well run, well managed open end index funds tracking the same indexes. (According to its NYTimes snapshot, the last time Vanguard 500 VFINX made a cap gains distribution was December 1999.) And in the case of Vanguard ETFs, there's no tax advantage to the ETF share class, because they are just a class of the same portfolio as the open end fund - so any gains are distributed among all share classes including the ETF share class.
Broad based index ETFs are (generally) low in expenses; but one can often find open end peers with similar ERs. In the case of Vanguard, the Admiral share class (currently) has the same ER as the ETF share class. And both of these tend to be lower than other families' ETFs. EAFE index? EFA (iShares) with its $46B in assets is larger than the rest of the EAFE ETF market. But its 0.34% ER is 70% higher than Fidelity's Spartan International Index (FSIIX's) Fund's 0.20% ER. Even Vanguard's VEA ETF at 0.12% ER costs more than the Advantage share class (FSIVX) of Fidelity's fund. So while ETFs generally cost less than open end equivalents, it's not a given.
The buy/sell mechanism of ETFs, IMHO is more of a detriment than a benefit (except to traders). There are commissions (unless buying at a broker who sells the particular ETF without commission). One of the benefits of ETFs was supposed to be that you could get them pretty cheap anywhere (you just paid a stock trade commission, as opposed to a mutual fund transaction fee which tends to be much higher). If you're relying on getting free ETF trades (because the ETF is on your broker's NTF list), then this benefit of ETFs goes away.
Aside from the possible commission, there's the bid/ask spread. My understanding is that what matters even more than how widely or thinly traded an ETF is, is how widely traded are its underlying securities. If its portfolio is thinly traded, then authorized participants will have a big overhead in buying up the securities necessary to make a creation unit. That means that even if the market price of the ETF rises above its NAV, the authorized participants won't immediately jump in to create more shares, sell the ETF shares, and move the market price back in line with the NAV. All this, because it costs them money to build that basket of thinly traded securities. Not a problem with, say, and S&P 500 ETF, but could be a problem with international ETFs or ETFs of smaller securities.
This gets us to tracking error. There are a couple of sources of tracking error. One is in the portfolio construction/management. All index funds have this problem - whether they are open end funds, ETFs, or any other structure. How well does the management select securities, time their purchases, manage index changes, etc. to track the index? Beyond that, ETFs have a second source of tracking error - the deviation of market price from NAV as just discussed. Not an issue with open end funds. (Open end funds have a different issue though - cash management - how to deal with cash coming in and out of the fund without mistracking due to variable amounts of cash.)
As negative as I must sound about ETFs, I still use them. When there's an index that I want to get and there's no less expensive alternative (taking into consideration the spread, commission, and time I expect to hold the position). When I'm buying a Vanguard index where the open end version has an entry or exit fee. (For example, VGAVX has a purchase fee of 0.75%, while the ETF share class VWOB is purchased on the stock exchange; both have the same ER).
All else being equal, I'll use open end funds; but all else is not always equal and ETFs can serve a role in a low turnover, broadly diversified personal portfolio.
In addition to msf's notations, the following links provide information about another part of etf's that should be a consideration for an investor; being whether options trading is allowed for a particular etf. An overview could be a hot market sector traveling positive or negative, the related etf's being traded at a rapid pace and then pile options trading onto the eft;s, too. Not to imply any problems with this; but an investor should be aware of this circumstance with a particular purchase.
I like and use ETFs, have eight of them: DTN, DVY, PJP, PKW, RHS, VIG, VNQ and XLP along with my 15 funds and 13 stocks which represent 63% of my portfolio I did recently sell EEM and put the proceeds into my two emerging market funds ODVYX and ABEMX and some into OAKIX. Also sold IYW and placed the funds into ISTIX. These are areas I think good managers can do better than the ETFs. I will admit though that my largest equity holding (but not by much) is PKW, so I do feel they can have a place in my portfolio and can have a positive impact on my returns over time.
I am still tweeking part of my portfolio which I inherited, but less so now than 6 months ago. No further changes are anticipated, except with a couple of trading stocks.
Glad the subjest was posted, I too wondered if others used them as much as I do.
Comments
I don't at this time use etfs within my portfolio. I feel etfs are designed to be traded and mutual funds are designed for investing. I just did not want to go the trading route. I have no problem with funds that I hold that use etfs as an aid in the deployment of their strategies. Again, form my thoughts etfs are designed to be traded.
Skeeter
Mutual funds may be best if you are doing periodic investing like dollar cost averaging but because online commisions are so low this days and ETF expense ratios are generally low lump sum investments may often result in lower expenses for ETFs.
It may be easier to do dividend reinvestment in funds
ETFs are very good for making a country or sector overweighting. For example If I believe that Egypt will come out of the current mess very well and prosper an investment in Egyptian stocks may look like a good idea and An ETF is the way to do that. The last sentence should NOT be interpreted as a suggestion to buy Egyptian stocks. I have no idea how well that would work out
In taxable accounts most ETFs are more tax friendly than most fund for reasons not easy to explain in a sentence though two paragraphs might not be needed.
In some cases its easier to find a "pure" investment For example If you had a crystal ball in 2008 and KNEW the best investment would be long term treasuries but corporate bonds would not do as well you might have to read a variety of prospectuses to find the right fund but finding the right ETF would have been less difficult.
Should have done same with AQRIX, but I was too dumb.
From the board, I've learned that when trading ETFs, be wary of volume, since Price and NAV can be quite different on lower volume offerings. So, be sure to look for more highly traded ones.
ETFs tend to be more index oriented, either to particular markets or sectors.
I personally favor active managers that have gained my trust (as misguided as that may be), so I generally hold no-load, open ended funds. Or, individual stocks.
Currently, no ETF holdings. I do think M* does good job of describing particular ETF pro-and-cons, if you subscribe to their premium service.
Then there are those ETFs that are designed for traders or gimmicky, expensive.
I meet John Bogle half way in my view of ETFs. Many are a lot of hype, encourage trading, and are not economical, either from an ER perspective, or from a tax perspective. (I'm largely echoing Investor's comment here).
The broad based index ETFs do mostly live up to their descriptions. They are indeed tax efficient (so long as they are market cap/free float based, or otherwise designed with buffers to reduce turnover). But so are well run, well managed open end index funds tracking the same indexes. (According to its NYTimes snapshot, the last time Vanguard 500 VFINX made a cap gains distribution was December 1999.) And in the case of Vanguard ETFs, there's no tax advantage to the ETF share class, because they are just a class of the same portfolio as the open end fund - so any gains are distributed among all share classes including the ETF share class.
Broad based index ETFs are (generally) low in expenses; but one can often find open end peers with similar ERs. In the case of Vanguard, the Admiral share class (currently) has the same ER as the ETF share class. And both of these tend to be lower than other families' ETFs. EAFE index? EFA (iShares) with its $46B in assets is larger than the rest of the EAFE ETF market. But its 0.34% ER is 70% higher than Fidelity's Spartan International Index (FSIIX's) Fund's 0.20% ER. Even Vanguard's VEA ETF at 0.12% ER costs more than the Advantage share class (FSIVX) of Fidelity's fund. So while ETFs generally cost less than open end equivalents, it's not a given.
The buy/sell mechanism of ETFs, IMHO is more of a detriment than a benefit (except to traders). There are commissions (unless buying at a broker who sells the particular ETF without commission). One of the benefits of ETFs was supposed to be that you could get them pretty cheap anywhere (you just paid a stock trade commission, as opposed to a mutual fund transaction fee which tends to be much higher). If you're relying on getting free ETF trades (because the ETF is on your broker's NTF list), then this benefit of ETFs goes away.
Aside from the possible commission, there's the bid/ask spread. My understanding is that what matters even more than how widely or thinly traded an ETF is, is how widely traded are its underlying securities. If its portfolio is thinly traded, then authorized participants will have a big overhead in buying up the securities necessary to make a creation unit. That means that even if the market price of the ETF rises above its NAV, the authorized participants won't immediately jump in to create more shares, sell the ETF shares, and move the market price back in line with the NAV. All this, because it costs them money to build that basket of thinly traded securities. Not a problem with, say, and S&P 500 ETF, but could be a problem with international ETFs or ETFs of smaller securities.
This gets us to tracking error. There are a couple of sources of tracking error. One is in the portfolio construction/management. All index funds have this problem - whether they are open end funds, ETFs, or any other structure. How well does the management select securities, time their purchases, manage index changes, etc. to track the index? Beyond that, ETFs have a second source of tracking error - the deviation of market price from NAV as just discussed. Not an issue with open end funds. (Open end funds have a different issue though - cash management - how to deal with cash coming in and out of the fund without mistracking due to variable amounts of cash.)
As negative as I must sound about ETFs, I still use them. When there's an index that I want to get and there's no less expensive alternative (taking into consideration the spread, commission, and time I expect to hold the position). When I'm buying a Vanguard index where the open end version has an entry or exit fee. (For example, VGAVX has a purchase fee of 0.75%, while the ETF share class VWOB is purchased on the stock exchange; both have the same ER).
All else being equal, I'll use open end funds; but all else is not always equal and ETFs can serve a role in a low turnover, broadly diversified personal portfolio.
An overview could be a hot market sector traveling positive or negative, the related etf's being traded at a rapid pace and then pile options trading onto the eft;s, too.
Not to imply any problems with this; but an investor should be aware of this circumstance with a particular purchase.
I-Shares with options
CBOE's list of options available with etp's
I also like some of the broad alternative-weighted ETFs such as:
PRF, FNDB, TILT, VIG, DEM, DGS, DGRE
I don't bet all index-passive nor all active products --- I combine the best of both worlds.
I am still tweeking part of my portfolio which I inherited, but less so now than 6 months ago. No further changes are anticipated, except with a couple of trading stocks.
Glad the subjest was posted, I too wondered if others used them as much as I do.
OJ