Not all Exchange Traded Funds (ETFs) are Created Equal

Written by: Ryan Bouchey

As you probably know, our firm is a big proponent and user of ETFs, for a multitude of reasons. Over the past couple of years the popularity of ETFs has soared, driven by both institutional advisors as well as the everyday investor. But when it comes to choosing the right ETF, there are many factors to consider past the sector or region you are trying to gain exposure to. I’m going to show you three examples of how important it is to look beyond just the name or expense ratio of a particular ETF to find the best ETF for your portfolio.

Sector Specific
We like to utilize ETFs when we think a particular sector of the market will outperform the broad market. This year we invested in the Consumer Discretionary sector because of improving wages, improving economy and low gas prices. If you felt the same way, you could easily pull up a number of Consumer Discretionary ETFs and think that by choosing one they will all perform similarly. Not all ETFs are structured the same way, and what’s most important is to research the underlying basket of securities. Let’s look at two funds – Consumer Discretionary Select SPDR (XLY) and Guggenheim S&P Equal Weight Consumer Discretionary (RCD). XLY is a Large Cap consumer discretionary fund that tends to favor technology and services over the traditional brick and mortar retailer. This is important because services make up 67% of consumer spending. RCD on the other hand is an equal-weighted consumer discretionary fund, meaning they give just about equal weighting to the underlying companies. Because of this, RCD has less exposure to some of the leading companies found in XLY. The difference YTD in performance is XLY is up 11.31% while RCD is down 0.93% – this is a greater than 12% variance between two Consumer Discretionary ETFs.
Country / Region Variances
Just as sector ETFs can vary in performance, so can ETFs based on regions or particular countries. For this example I looked at two ETFs covering European equities over the past year – iShares Core MSCI Europe (IEUR) and SPDR Euro STOXX 50 (FEZ). Both funds obviously have Europe in their names, and if you wanted pure exposure to Europe you may feel as though either of these two options would work for you, but as you dig deeper there are some differences. IEUR covers a very broad range of European companies, ranging from large-cap to small-cap. Its performance over the past 12-months has been down 5.48%. FEZ on the other hand only focuses on the 50 largest European companies. Its performance over the same range has been down 9.85% – almost double what IEUR has been down.
Currency Exposure
When investing overseas, currency exposure is something you must factor in as well. If you invest in a basket of European equities, their performance is dependent on currency factors. An example we’ll use here is the difference between iShares MSCI Europe (IEUR) which we used above and the WisdomTree European Hedged Equity (HEDJ) ETF. Both ETFs track the same benchmark, but HEDJ is hedged against the Euro for U.S. investors so currency exposure does NOT come into play. During a year like 2015 when the Dollar appreciated greatly against the Euro (one of the big reasons why U.S. earnings are down due to overseas sales), this currency hedge makes a big difference. YTD IEUR is down 1.2% while HEDJ is actually up 6.5%. This spread was even greater in 2014 when at times their performance varied by as much as 30% all due to the lack of exposure to the Euro.
Those are three great examples of the complexities involved when investing in ETFs and how these complexities effect performance. Many times they are marketed as plain vanilla and straight-forward but ETFs come in all shapes and sizes and it’s important to make sure you know exactly how your ETF is invested.