Any investor who hasn’t been living under a rock probably has some idea as to why the ETF industry has been expanding so quickly over the last several years. Intra-day liquidity, enhanced tax efficiencies, and a degree of transparency not available in many other structures are all common causes of the explosive growth in both number of products and ETF assets over the past decade. But the big driver of the ETF expansion relates to expenses–or perhaps more accurately, the lack thereof.
ETFs were originally designed (at least in part) to combat what Vanguard founder John Bogle has called the “tyranny of compounded costs.” For investors who believe that security selection fails to consistently add value–and there is a boatload of academic evidence that supports that theory–paying for pricey active management does little more than erode returns over the long run. Most ETFs are passive in nature, meaning that they seek to replicate the performance of a specific benchmark. That means low overhead, which translates into lower fees for investors.
As competition between ETF issuers has heated up in recent years, many have sought to differentiate their products on the basis of cost. So while many of the new ETFs hitting the market are more targeted and sophisticated products–and as such charge expenses above the industry average–fees on many existing products have been cut in an effort to appeal to cost conscious investors. That downward pressure on fees has primarily targeted “plain vanilla” products, making it possible for investors seeking to construct a low cost, buy-and-hold portfolio with a minimal price tag [see FocusShares Debuts Low(est) Cost ETFs].
But just how cheap can it be to develop a well-balanced all-ETF portfolio that maintains exposure to all the major asset classes? We examined the cheapest ETF options out there to come up with a portfolio that includes broad based exposure to domestic and international equities, fixed income, and even commodities [to see all of our model ETF portfolios, sign up for a free trial to ETFdb Pro]:
|30%||FMU||Focus Morningstar US Market Index ETF||0.05%|
|15%||VEA||Vanguard Europe Pacific ETF||0.15%|
|15%||VWO||Vanguard MSCI Emerging Market ETF||0.22%|
|30%||BND||Vanguard Total Bond Market ETF||0.12%|
|10%||DJCI||Dow Jones-UBS Commodity Index ETN||0.50%|
Focus Morningstar US Market Index ETF (FMU)
This ETF is part of a suite of recently launched FocusShares ETFs that undercut competitors from an expense perspective. FMU, found in the All Cap Equities ETFdb Category, offers an option for broad-based exposure to U.S. equity markets in a single ticker. The underlying index consists of more than 1,500 individual securities, including large cap, mid cap, and small cap U.S. stocks. The index components accounts for the top 97% of U.S. market capitalization. FMU may be tilted towards large cap stocks, but the wide net cast by the related benchmark ensures that investors can achieve exposure to small and mid caps as well.
Other low cost options for broad-based U.S. market exposure include Vanguard’s VTI (which charges 0.07%) and Schwab’s SCHB (which comes in at 0.06% annually). For investors with a Scottrade account, FMU can be traded commission free–adding even more appeal to those interested in minimizing the cost of rebalancing.
Vanguard Europe Pacific ETF (VEA)
This ETF offers low cost exposure to developed markets outside the U.S.; VEA’s holdings include more than 900 individual securities from more than a dozen different markets. These include stocks listed in Western Europe, Japan, and Australia. VEA is one of several products to target the EAFE region that includes Europe, Australasia, and the Far East, and is by far the cheapest option in the group. iShares offers a similar product that targets the same benchmark as VEA–the MSCI EAFE Index–but EFA charges an expense ratio of 0.35%.
VEA, like all Vanguard ETFs, is eligible for commission-free trading to Vanguard brokerage clients.
Vanguard MSCI Emerging Markets ETF (VWO)
With total assets of more than $47 billion at the end of March 2011, VWO is one of the largest ETFs available to U.S. investors. And this fund, which seeks to replicate the MSCI Emerging Markets Index, is one of the cheapest options for gaining exposure to the developing economies of the world. VWO has more than 850 holdings, with the largest country allocations going to China, Brazil, South Korea, and Taiwan [see VWO holdings].
VWO’s surge is perhaps the best piece of evidence that investors are embracing low cost ETFs. This fund saw inflows of about $1.9 billion during the first quarter of 2011; EEM saw outflows of more than $9 billion during the same period. Both ETFs are linked to the same index, but VWO (0.22%) maintains a significantly lower expense ratio than EEM (0.69%). At the end of March 2010, VWO had only about $49 billion in assets–compared to $40 billion for EEM [Emerging Market ETFs: Seven Factors Every Investor Must Consider].
UBS E-TRACS DJ-UBS Commodity Index Total Return ETN (DJCI)
This commodity fund offers exposure to a basket of futures contracts, spreading exposure across nearly 20 different natural resources. The largest target weights are to crude oil (14%), natural gas (12%), gold (9%), and soybeans (8%), with all types of commodities represented in the underlying DJ-UBS Commodity Index Total Return. DJCI, which is structured as an exchange-traded note (ETN), charges just 0.50% in expenses annually, considerably cheaper than many similar products [see When ETNs Are Better Than ETFs].
DJCI may be the ETF industry’s best kept secret; at the end of March this ETN had just $27 million in assets. The iPath Dow Jones-UBS Commodity Index Total Return ETN (DJP) is linked to the exact same index as DJCI, but charges an additional 25 basis points in expenses annually. Yet DJP finished March with nearly $3.3 billion in assets [Are Investors Embracing Low Cost ETFs?].
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Disclosure: No positions at time of writing.