The Problem With Dow ETFs

by on February 2, 2010 | Updated November 20, 2012 | ETFs Mentioned:

The Dow Jones Industrial Average is one of the most widely-followed stock indexes in the world, seen as a barometer of U.S. equity market performance. The rise of the ETF industry has given investors the option to track the performance of this benchmark, and a number of spin-offs have increased ETF options for investing in the Dow. But before buying into one of the available Dow ETFs, investors should be aware of the potential drawbacks and limitations associated with each of the funds [see also Free Report: How To Pick The Right ETF Every Time].

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History Of The Dow

The Dow is one of the market indexes created by Wall Street Journal editor and Dow Jones founder Charles Dow, who named the benchmark jointly after statistician Edward Jones. The benchmark is the second oldest in the U.S., behind only the Dow Jones Transportation Index. The composition of the index has changed gradually over the years, and the current version of the benchmark has limited exposure to the industrial sector that once dominated holdings (accounting for the use of “industrial” in the name). Exxon Mobil (XOM) has been included in the DJIA since 1928 (originally as Standard Oil), while other components were added as recently as 2009 [sign up for the ETFdb newsletter to get updates and analysis].

Dow Drawbacks

The Dow’s popularity in the investing community is perhaps more attributable to the long history and visibility of the index rather than its efficiency as an equity market benchmark. The Dow is a price-weighted benchmark, meaning that higher-priced stocks are given more weight than lower-priced counterparts. Moreover, because the index includes only 30 component stocks, it doesn’t always provide a good representation of overall market performance. By comparison, the S&P 500 Index is a float-adjusted market cap-weighted benchmark with a much broader base of holdings [see also The Truth About Alternative Weighting Methodologies].

Dow ETFs

Despite the potential drawbacks of investing in the Dow highlighted above, there are several ETFs based on the DJIA that have become popular with investors:

Ticker ETF Expense Ratio
DIA State Street Dow Jones Industrial Average 0.16%
DOD ELEMENTS DJ High Yield Select 10 ETN 0.75%
Updated as of 11/20/2012

Inverse And Leveraged Dow ETF Options

For investors looking to gain inverse or leveraged exposure to the Dow Jones Industrial Average, ProShares offers a handful of ETF options:

Ticker ETF Expense Ratio
DOG ProShares Short Dow30 0.95%
DDM ProShares Ultra Dow30 0.95%
DXD ProShares UltraShort Dow30 0.95%
Updated as of 11/20/2012
  • ProShares Short Dow30 (DOG): This ETF seeks daily investment results that correspond to the inverse of the daily performance of the DJIA.
  • ProShares Ultra Dow30 (DDM): This ETF seeks daily investment results that correspond to 200% of the daily performance of the DJIA.
  • ProShares UltraShort Dow30 (DXD): This ETF seeks daily investment results that correspond to 200% of the inverse of the daily performance of the Dow.

Under The Hood: DOW ETFs

Dow Diamonds (DIA)

This ETF seeks to provide investment results that correspond to the price and yield performance of the Dow Jones Industrial Average, and is one of the largest and most widely-traded U.S. ETFs. Boasting over $9 billion in assets under management, DIA is easily one of the largest ETFs by market cap; with average daily trading volumes topping 5 million shares, DIA is also among the most liquid ETFs.

DIA’s holdings match the underlying index almost exactly, meaning that this ETF is comprised of 30 mega-cap ETFs–the median market cap exceeds $100 million. The difference between DIA’s market value and the return on the DJIA has approximated the fund’s expense ratio since its inception more than 12 years ago, indicating that DIA is generally efficient in minimizing tracking error. From a cost perspective, DIA is fairly competitive, charging an expense ratio of just 0.16% for Large Cap Value Equities exposure.

ELEMENTS Dogs of the Dow ETN (DOD)

This exchange-traded note is linked to the Dow Jones High Yield Select 10 Total Return Index, a benchmark that offers investors exposure to the highest yielding components in the DJIA. Each December, the thirty stocks in the Dow Jones Industrial Average are ranked by indicated annual dividend yield; next, the ten stocks with the highest indicated annual dividend yield are selected as index components [see Monthly Dividend ETFdb Portfolio].

The “Dogs of the Dow” investment strategy was introduced in the early 1990s by money manager Michael B. O’Higgins in the book “Beating the Dow”. Given this targeted approach in selecting the highest yielding companies, it’s fairly easy to see how this ETN could appeal to investors who are looking to maximize current income [see Dividend ETF Investing: Four Critical Factors To Consider].

Fees are a major drawback of pursuing this investment strategy through an ETN: DOD charges a fairly steep expense ratio of 0.75% for implementing a strategy that is relatively easy for most investors to execute on their own at a much cheaper rate. It should also be noted that DOD is structured as an exchange-traded note, meaning that it exposes investors to credit risk of the issuing institution.

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Disclosure: No positions at time of writing.