How can you use ETFs? A wide diversity permits many applications.
- An ETF based on a large benchmark like the S&P 500 allows you to quickly gain exposure to a wide and diversified portfolio of stocks. The management fee is typically 3-10 bips or 0.03 to 0.1% for one of those instruments.
- The Q’s (QQQ), which track the Nasdaq has an expense ratio of 20 bp.
- The SPDR’s – the sector ETFs from State Street – currently have an expense ratio of 12 bp.
A wide diversity of ETF strategies and asset classes – History
- The second group of ETFs which followed the S&P 500 in 1993 were the regional ETFs introduced by iShares (BlackRock) in 1996. These ETFs are US-listed funds (traded on a US exchange), but are investing in foreign stocks and tracking MSCI indices. You will find among them.
- More of these country ETFs were introduced a few years later.
- The SPDRs, aka the sectors ETFs from StateStreet called “Spiders”, were introduced in December 1998. The most famous ones are:
- The small cap indices issued by iShares in December 2000. They are most well-known for its Russell 2000 ETF, but they also have style variants (Growth, value…) and S&P Small cap references. The main ETFs are:
- The venerable EFA ETF from BlackRock is the main regional “Developed Markets” ETF. It was introduced in 2001 and tracks the MSCI EAFE (Europe, Asia and Far East). It has an AUM of $55 bn right now.
- The Vanguard equivalent came only in 2009. There are now ~450 bond ETFs.
These are indices, which have the same constituents as the regular indices, but whose weights are based on a given style, not the market capitalization of the companies.
For instance EWI is the equi-weighted index of the S&P 500. At every rebalance, all the stocks are re-weighted so that they have the same weight in the index. In that Index Apple has the same weight as Conoco-Philips or Caterpillar.
You can also weight indices based on their ‘value’, their ‘dividend’, their ‘Earning per share’… or any other criteria.
The industry sectors also have their equi-weighted indices and ETFs.
These ETFs tend to have slightly higher turnovers and volatilities than their regular counterparts.
- The Wisdom Tree DLN is the S&P 500 Dividend-weighted ETF. It has a yield of 2.65% (vs. 2-2.2% for the regular S&P 500).
- The USO ETF, is based on the oil futures, not the oil physical (barrel). It is famous for having lost 30% of its value in just one week, in April 2020. There was no more storage capacity and the futures roll became strongly negative: many futures holders could not accept delivery. It is $3.bn in AUM… now.
They have limited appeal, since FX are easy to trade.
- With >120 different funds, they represent a small amount of AUM (~$50 bn), but have attracted a lot of attention, notably for their risks.
- They can be found for almost all asset classes. They have a relatively high expense ratios (~1.1%).
- Because of their constant rebalancing, they have a significant drag, and their long term values is always zero.
- Min volatility: stock of lower volatilities tend to outperform (essentially by avoiding the big crashes).
- Momentum factor. Stocks which outperform tend to outperform for a long period. When you invest in momentum, you buy stocks which have done well, you sell stocks which have done poorly, with the expectations that their trend will continue. That momentum characteristic is actually one of the strongest ‘anomalies’ documented by academic research.
- Quality: ‘quality stocks’ tend to outperform in the long term.
- Volatility ETFs
- Real Estate
- Active ETFs (not benchmarked against an index)
The other asset classes are even smaller, if not symbolic.
Use of ETFs – many applications
- Make quick tactical adjustment to their portfolios:
→ buy exposure, sell exposure,
→ more bond less equities,
→ reduce value, add momentum.
- Acquire a core allocation of a portfolio, on which they add a tilt done on top, for instance:
→ Long S&P with a core SPY position,
→ but short the technology and financials,
→ add industrials and healthcare.
- rebalance the portfolio based on on sectors or factors:
→ Play the economy cycle: low discretionary, high food & staples,
→ Reduce the momentum due to the FAANG in large benchmarks.
- You can gain International exposure:
→ Reduce US and Europe by selling SPY, EWU, EWG,
→ Buy Japan and Brazil with EWJ and EWZ.
- Do overlays with options in a diversified manner.
→ Buy SPX, a basket of sectors, a basket of shares,
→ Sell calls on the SPY.