UPDATE: ETFs are getting cheaper, but fees shouldn't be the main criteria
By Jared Dillian
A former head of ETF trading at Lehman Brothers shares his insights
There is a massive price war going on in ETF Land. Issuers are falling over themselves in a race to see who can charge the lowest fees.
Clearly, they're doing it because it works. For many investors, low fees were the main reason you are invested in exchange traded funds.
I saw some funds the other day that had expense ratios of 0.04%. That's 4 basis points, meaning that if you invest $10,000, you pay $4 in fees.
In order for the fund issuer to earn $4 million in fees, the ETF has to have $10 billion in assets, and that is no small feat -- only a handful of ETFs have managed to do that. So anyone who issues an ETF with 4 basis points in fees is doing so at a loss.
That's capitalism in 2017. Producers impale themselves, consumers win. Somehow those businesses are worth something. (The passive investing bubble is one of the market distortions I cover in my latest report, "Investing in the Age of the Everything Bubble (http://www.mauldineconomics.com/go/v37jlx/mkw).")
I stand by what I recently said about high broker commissions being better for investor psychology (http://www.mauldineconomics.com/go/v37jm3/mkw), but you should ruthlessly exploit funds with low expense ratios. There's no psychological benefit to a higher expense ratio; you're just paying more, after all.
But fees are not everything. In fact, fees are only one of many considerations when you're choosing an ETF -- and they're far down the checklist.
How do you choose an ETF?
First, you have to answer the following question: What kind of ETF do you want? (http://www.mauldineconomics.com/go/v37jm6/mkw) Debt or equity? Sector, currency or commodity? Global or international?
Let's say you want an energy ETF. Well, there are 28 of them. For time's sake, we won't consider all 28 here, but let's look at the top five in terms of assets:
-- Energy Select Sector SPDR ETF (XLE)
-- Vanguard Energy ETF (VDE)
-- SPDR S&P Oil & Gas Exploration & Production ETF (XOP)
-- VanEck Vectors Oil Services ETF (OIH)
-- iShares US Energy ETF (IYE)
Let's say you want a broad-based energy ETF. That rules out XOP and OIH, which are subsector funds.
The next step is to dig down into the holdings of the ETF to see how the stocks are weighted and how top-heavy or concentrated it is.
Energy Select Spider ETF (XLE) -- top 10 holdings Company Ticker Index weight Exxon Mobil Corp. US:XOM 22.1% Chevron Corp. FR:CV 17.3% Schlumberger Ltd. US:SLB 7.6% ConocoPhillips US:COP 4.7% EOG Resources Inc. US:EOG 4.4% Occidental Petroleum Corp. US:OXY 3.9% Phillips 66 US:PSX 3.1% Kinder Morgan Inc. US:KMI 3.1% Halliburton Co. US:HAL 3.1% Valero Energy Corp. US:VLO 2.7% Source: SPDR Vanguard Energy ETF (VDE) -- top 10 holdings Company Ticker Index weight Exxon Mobil Corp. US:XOM 22.4% Chevron Corp. FR:CV 15.1% Schlumberger Ltd. US:SLB 6.6% ConocoPhillips US:COP 4.0% EOG Resources Inc. US:EOG 3.7% Occidental Petroleum Corp. US:OXY 3.4% Phillips 66 US:PSX 2.9% Kinder Morgan Inc. US:KMI 2.9% Halliburton Co. US:HAL 2.5% Valero Energy Corp. US:VLO 2.3% Source: Vanguard iShares US Energy ETF (IYE) -- top 10 holdings Company Ticker Index weight Exxon Mobil Corp. US:XOM 24.1% Chevron Corp. FR:CV 15.5% Schlumberger Ltd. US:SLB 6.7% ConocoPhillips US:COP 4.1% EOG Resources Inc. US:EOG 3.8% Occidental Petroleum Corp. US:OXY 3.4% Phillips 66 US:PSX 2.7% Kinder Morgan Inc. US:KMI 2.7% Halliburton Co. US:HAL 2.6% Valero Energy Corp. US:VLO 2.3% Source: iShares
You can see there isn't a lot of differentiation among the indices; you're essentially getting the same basket. So if you're indifferent among the three, then look at the fees:
-- XLE: 0.14%
-- VDE: 0.10%
-- IYE: 0.44%
That basically rules out IYE. So now we're down to deciding between XLE and VDE.
One thing a lot of people don't consider: If you're a customer of a full-service brokerage and you pay commissions on a cents-per-share basis, you want an ETF with a high dollar-price-per-share to minimize commissions.
In this case, that would mean VDE ($91) over XLE ($66). But if you are a customer of a discount brokerage, it doesn't really matter.
One final concern is liquidity (http://www.mauldineconomics.com/go/v37jm9/mkw). You can get into this thing, but can you get out? All of these funds are pretty liquid, so liquidity is not a concern here.
And that's how you choose an ETF.
But people won't pay for money management, even though it's way more important to their financial future (http://www.mauldineconomics.com/go/v37jmd/mkw). It's bizarre.
As a Wall Street veteran and former Lehman Brothers head of ETF trading, Jared Dillian has traded through two bear markets. In this report (http://www.mauldineconomics.com/go/v37jlx/mkw), you will learn how to properly position your portfolio for the coming decline he is predicting.
-Jared Dillian; 415-439-6400; AskNewswires@dowjones.com
(END) Dow Jones Newswires