The Morningstar Awards recognize ETFs offering superior investor experiences.
Morningstar is pleased to announce the winners of its second-annual Morningstar Awards for ETFs. These awards recognize fund families for providing low-cost, index-based investments and are based on the number of winners in each category group. This year, iShares won three ETF Provider awards while Vanguard won one. At the category level, iShares had 31 category winners, Vanguard had 23, and SPDR had 10. PowerShares, Schwab, WisdomTree, First Trust, and Guggenheim also had category winners.
One of the key drivers underpinning the continued growth of exchange-traded funds is their low costs. However, the true cost of owning an ETF includes more than just the headline expense ratio. And the total cost of ownership can vary depending on investors’ holding period and their need for liquidity. These awards recognize that not all investors are created equal. They distinguish between two classes of investor: those with a longer-term investment horizon--the “Investor” class--and those more concerned about the need for immediate liquidity--the “Trader” class. From each eligible Morningstar category, a category winner is chosen for both the Investor class and the Trader class. The ETF Provider with the most category winners in an eligible category group wins the Morningstar Award at that category group level. These awards are completely quantitatively driven, taking into account total cost of ownership as well as risk-adjusted performance. But unlike the Morningstar Rating, which awards stars based solely on past risk-adjusted performance within a fund’s category, the Morningstar Awards lean heavily on total cost of ownership. A complete list of winners can be found here, and the complete methodology can be found here.
iShares Wins Big
IShares had the most category winners, with 10 for the Investor class and 21 for the Trader class for a total of 31 winners. As one of the oldest and the largest ETF providers, iShares had by far the most eligible ETFs. IShares ETFs typically have among the best liquidity in their respective categories, so it is not surprising to see them win so many awards for the trader class. But they also won a large number of Investor class awards. Last year, iShares reaffirmed its commitment to providing low-cost ETFs through the launch of the iShares Core suite, which consisted of expense ratio reductions for several ETFs and the launch of new ETFs with low expense ratios. While the new ETFs are not yet eligible for awards, three ETFs in the iShares Core suite won their respective categories.
While iShares had 10 category winners in the Investor class, Vanguard had the most category winners in the Investor class with 15. Vanguard also won eight at the Trader level for a total of 23 category winners. It is important to note that 18 Vanguard ETFs changed indexes during the year, including nine that won awards last year. The index changes reduced the number of eligible Vanguard ETFs, because the award methodology requires that an ETF track the same index for at least 13 months to verify that an ETF is tracking its index well. Vanguard’s stated objective in making the index changes is in keeping with the spirit of the awards, which is to provide low-cost access to index funds.
State Street Global Advisors, which issues the SPDR ETFs, had 10 category winners, three at the Investor class level and seven at the Trader class level. Both PowerShares and WisdomTree increased the number of categories they won over last year, when they each had one category winner. This year PowerShares had six category winners, three in the Investor class and three in the Trader class while WisdomTree won four, all in the investor class.
In its first year of eligibility for the Awards, Schwab ETFs had category winners in the Investor class for the large-blend, large-growth, foreign large-blend, and diversified emerging-markets equity categories. Last year, Schwab announced expense ratio reductions for several of its ETFs. As a result of these fee cuts, the Schwab ETF lineup now has the lowest asset-weighted expense ratio of all ETF providers. However, some of the categories in which Schwab won awards were categories in which Vanguard funds won last year but were ineligible to win this year. For example, in the large-blend category, Schwab U.S. Broad Market ETF SCHB won the award in the Investor class due to its low cost. The fund charges just 0.04% and returned 21.47% in the year ended June 30, 2013, compared with 21.43% for the index. Last year, Vanguard Total Stock Market ETF VTI won the Investor award in that category. VTI has a stated expense ratio of 0.05%, just 1 basis point more than the Schwab fund and its portfolio delves deeper into small-cap territory.
While Schwab U.S. Broad Market ETF was the Investor class winner in the large-blend category, the Trader class winner was a race between three liquid ETFs, SPDR S&P 500 ETF SPY, iShares Core S&P 500 ETF IVV, and iShares Russell 1000 Index IWB. SPY won the award last year due to its abundant liquidity, as the ETF trades nearly $20 billion a day. The large trading volume and tight tracking to NAV result in the lowest estimated market impact cost of any ETF, meaning that large blocks of shares could be easily traded without a significant impact on the fund’s market price from NAV. However, market impact costs is only one of two components in the total cost of ownership, the other being estimated holding costs. The difference in returns between an ETF and its benchmark index is captured by the estimated holding cost. SPY’s estimated holding cost is actually higher than its expense ratio, meaning it lagged the index by more than one would expect—assuming otherwise perfect tracking. For the year ended June 30, 2013, the S&P 500 Index returned 20.60% while SPY returned 20.44%, lagging its index by 16 basis points, more than its 9 basis point expense ratio. Meanwhile, iShares Core S&P 500 ETF returned 20.52%, lagging the index by only 8 basis points. IVV is typically able to hew more tightly to the index through the reinvestment of dividends and contributions from securities lending income, two techniques prohibited by SPY’s unit investment trust structure. So while IVV has a slightly higher market impact cost than SPY, its lower estimated holding cost can result in a lower total cost of ownership for an assumed $1,000,000 trade--the trade size that is assumed in calculating Trader class winners.
After SPY and IVV, the ETF in the large-blend category with the next lowest total cost of ownership was iShares Russell 1000 Index. Due to the strong performance of mid-caps over the past several years, IWB has offered a better return than SPY or IVV, even on a risk-adjusted basis. That performance difference was enough to make IWB the large blend category winner for the Trader class. It offers a good combination of liquidity, index tracking, and index performance.