Comparing Sector ETFs and ETNs

By  SEP 24, 2012 12:10 PM

Exchange traded funds (ETFs) are a perfect tool for asset allocation. But be careful -- ETNs are lumped in the same category, but can be very different in terms of holdings, fees, and liquidity.


I am a big fan of asset allocation. Having investments that zig when others zag reduces downside risk and increases compound annual returns. I wrote a four-part series on the topic as well as a special report entitled Asset Allocation Strategies. The report includes actual portfolios with specific ETFs and ETNs mentioned.

ETFs Are Perfect for Asset Allocation.

For the quickest-fire exposure to all of the important asset classes, exchange-traded funds (ETFs) are the way to go. With just one purchase, you can achieve diversified exposure to virtually anything, be it China, commodities, health care stocks, or precious metals. In a March 2008 joint survey of investment professionals conducted by State Street Global Advisors and the Wharton School of Business, 67% characterized exchange-traded funds as “the most innovative investment vehicle of the last two decades” and 60% stated that ETFs had “fundamentally changed the way they constructed investment portfolios.”

The problem is that there are too many ETF choices, about 1,000 at last count. How does one know which ETF in each asset class to buy? I can’t go through all 1000 ETFs and ETNs in this article, but I can lay down some criteria to use in sifting out the ETF/ETN winners. Things to look for include:
I’ll look at a few different sector funds and crown a winner based on the criteria above. To help me on my quest, I found three ETF comparison tools on the Web that look useful:

So enough talk; let’s start the ETF Smackdown!

S&P 500 Funds

The contenders are the S&P 500 Spiders (NYSEARCA:SPY), iShares S&P 500 (NYSEARCA:IVV), and Vanguard S&P 500 (NYSEARCA:VOO):

Winner: iShares. IVV has better performance, decent trading volume, and a legal structure that allows the reinvestment of dividends. In contrast, SPY’s unit investment trust structure doesn’t allow dividend reinvestment. I’m a big believer in reinvesting dividends, so IVV takes the cake. Vanguard’s VOO offering has a minuscule 0.05% expense ratio, but its average daily trading volume is only 725,000 shares and I want more liquidity before jumping on board.

General Bond Funds

The contenders are Vanguard Total Bond Market (NYSEARCA:BND), iShares Barclays Aggregate Bond Fund (NYSEARCA:AGG), and SPDR Barclays Capital Aggregate Bond (NYSEARCA:LAG):

Winner: Vanguard. BND has the best trading volume, the cheapest expense ratio, and its unique structure as a share class of the huge VBTLX open-end fund gives it broader exposure to the bond market than the other ETFs, so less tracking error. General Commodity Funds

The contenders are iPath DJ-UBS Commodity ETN (NYSEARCA:DJP), PowerShares DB Commodity (NYSEARCA:DBC), and iShares S&P GSCI (NYSEARCA:GSG):

Winner: PowerShares. It is the best performer of the three this year and sports the most daily volume. Energy is a good place to be going forward.

As an ETN instead of an ETF, owners of the iPath product run the risk of Barclays defaulting but I feel good about Barclays — LIBOR scandal notwithstanding. It is one of the three largest banks in the United Kingdom. Furthermore, it “stole” Lehman Brothers’ assets out of bankruptcy for a song and did not require a bailout from the British government during the 2008-2009 financial crisis (unlike many others). Lastly, an ETN does not have any tracking error (other than management fees) because it does not own actual commodities but is simply a contractual agreement to return the index.

China Funds

The contenders are SPDR S&P China (NYSEARCA:GXC), iShares FTSE/Xinhua China 25 (NYSEARCA:FXI), and Guggenheim China All-Cap (NYSEARCA:YAO):

Winner: SPDR. Its trading volume is low, but I like its superior performance, cheap expense ratio, and its lower exposure to financial services. Health Care Funds

The contenders are SPDR Health Care (NYSEARCA:XLV), iShares Dow Jones US Healthcare (NYSEARCA: IYH), Vanguard Health Care (NYSEARCA:VHT), and PowerShares Dynamic Healthcare (NYSEARCA: PTH):

Winner: Vanguard. It ties iShares for the best performance, but offers more liquidity and has a much lower expense ratio. The SPDR is the worst performing, but it is the cheapest and the most liquid. Since I’m a diversification junkie, I’m going with Vanguard because it owns the largest number of stocks in its portfolio.

This article by Jim Fink was originally published on Investing Daily.

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