Three Intriguing Alternatives To Popular ETFs (SPY, XLF, FXI)

by on July 29, 2011 | ETFs Mentioned:

As the ETF industry has maintained its strong growth, investors have grown increasingly comfortable with establishing exposure to various markets utilizing the exchange-traded structure. Now, with 1,300+ funds in the space, there is an ETF for almost any investment objective, with further innovation still on the way. But as the industry rapidly expands, some funds will be on the receiving end of ETF growing pains, as many have a hard time trusting younger or less-popular products; but this lack of faith may represent a major missed opportunity for some investors.

In many cases, investors can be quick to take an ETF’s reputation or age at face value, and look no further. And it would be hard for anyone to accuse some of these ultra-popular and successful products of not meeting expectations, especially for those who value liquidity above all else. But when investors begin to look beyond the surface of some of these big-name funds, they may find that the lesser-known alternatives present a better fit for their portfolios or investment style. Below, we outline three very popular ETFs, all of which are the among the top 25 most actively traded exchange traded funds, and alternatives that may present a better play on their respective sector or market.

SPY vs. RSP

It is no secret that the SPDR S&P 500 (SPY) is the most popular ETF in the world, with roughly $95 billion in assets and an average daily volume well over 150 million, this ETF offers exposure to all 500 companies in S&P’s most famous index with an incredibly cheap expense ratio to boot. Additionally, SPY pays out a healthy dividend yield of 1.84%, adding extra income to investor gains. But a closer look reveals that this fund may be missing some key exposure by granting more weighting to those companies with a higher market capitalization, leaving the fund heavy in allocations to financial and energy firms [see also Details Of Dividend ETFs: Consistency vs. Yield].

Enter the S&P Equal Weight ETF (RSP) from Rydex. This fund tracks the same index, but instead of weighting by market capitalization, allocates assets to the S&P 500 Index on an equal weight basis, meaning that no one stock makes up more than 0.22% of the fund. From a holdings standpoint, RSP is one of the best diversified funds in the space, but investors may be skeptical as to its performance, after all, it grants the same weight to Cliffs Natural Resources as it does to Apple and Exxon Mobil. But when comparing past performances, RSP emerges as the victor; this ETF has gained 7.8% in 2011 while SPY has only returned 5.4%. Looking a bit deeper, one, three, and five year gains for RSP all top those of SPY, turning the heads of some investors. Though RSP is a more expensive product, the difference in returns between these two funds has more than accounted for the expense differences in recent years, making RSP an attractive opportunity for investors looking for an alternative to SPY [see also RSP Just Keeps Plugging Along].

XLF vs. VFH

The Financial Select Sector SPDR (XLF) is the best-known option for gaining exposure to the U.S. financial sector; a corner of the market that has been under a mountain of scrutiny in recent years. Despite our financial woes as a nation, XLF maintains $7.2 billion in assets and has an average volume of 77.8 million shares, making it one of the mostly actively traded products in the US. But XLF’s diversity leaves something to be desired, as it has 83 holdings, yet the top ten account for more than half of the ETF’s assets. And when it comes to market cap breakdown, XLF is primarily giant and large cap, while a small amount of assets are left for mid caps, neglecting small and micro altogether. All in all, XLF features a somewhat restricted exposure to the financials sector, and lacks the diversity that some investors demand, especially those who are seeking truly broad exposure to this market segment [see also ETF Insider: Maybe The World Isn’t Ending].

The Financials ETF (VFH) from Vanguard, though slightly more expensive, may give investors better exposure to the U.S. financial sector. The first thing to notice is that VFH has more than five times the amount of holdings of XLF; its 500 holdings give much better variety and exposure than its State Street counterpart. VFH also features significant exposure to mid, small, and micro cap companies, which gives investors a broader net to cast over the financials industry, as the ETF is not saddled with simply the biggest and best known companies. After all, in many cases, the most popular option is not necessarily the best. VFH’s strategy has also yielded better returns; VFH has outperformed XLF every year since 2006 (with the exception of 2009). This suggests that for investors seeking broad financial sector exposure, VFH could be a quality choice, especially for those looking for heavily allocations to mid and small cap firms.

FXI vs. ECNS

The FTSE China 25 Index Fund (FXI) is, without a doubt, investors’ go-to pick for gaining exposure to the Chinese economy. This fund aims to invest in the largest companies in China, ideally giving investors “ground floor” allocations to the rapidly developing country. The ETF has a current market cap of just over $6.8 billion and changes hands over 15.7 million times daily. While the fund may be extremely liquid, it isn’t very diverse. FXI holds just 28 companies, the top ten of which receive nearly 60% of the fund’s assets, effectively narrowing exposure to just a handful of individual securities. Furthermore, financials constitute an outsized portion of the fund’s total assets while consumer and technology firms do not receive any allocations at all. Another issue to note with these large cap companies is the fact that they are typically multinational firms that do business in many other regions besides China, which may also dilute exposure to this powerful economy [see also BRIC ETF Investing: Small Cap Edition].

Investors should consider MSCI China Small Cap Index Fund (ECNS) when it comes time to make their China allocations. This ETF seeks to invest in small cap companies domiciled in China. While small caps can present more risk and volatility, their business usually takes place entirely within their home country, so this ETF will likely be more of a “pure play” on the Chinese economy. ECNS has over 350 holdings, with no single company accounting for more than 1.31% of the ETF, meaning that exposure will be well diversified and no single company will be able to dictate the performance of this fund. Furthermore, consumer and technology companies make up healthy levels of the fund’s exposure while financials are relegated to a sub-four percent holding, meaning that even if investors buy up both China ETFs they will not see much overlap from a sector perspective. While FXI would never be considered a stand-alone China holding due to its lack of diversity, ECNS may be all you need to gain healthy exposure to this emerging economy, and to top it all off, ECNS comes in seven basis points cheaper than its more popular counterpart.

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Disclosure: No positions at time of writing.