When Bigger Isn’t Better: Profiling ETF Alternatives To DJP, FXI, GLD

by on March 20, 2012 | ETFs Mentioned:

As far as the majority of the ETF industry is concerned, size is everything. Institutions and financial advisors often have minimum AUM requirements for investing; a pre-screen that many ETFs fail due to their smaller size. Even individual investors are quick to write off a fund with low assets, as they assume its low popularity simply means that the fund is not of a high quality. Instead, most go with the biggest fund in the respective asset class, believing size to be the key factor. To put it rather bluntly, most of the aforementioned people and groups can often be wrong. There are a number of smaller products that present much more compelling investment methodologies than their larger counterparts, they just need a little more attention to get going.

Below, we outline three popular funds in the ETF world and offer smaller alternatives that outdo their competitors in one way or another.

SPDR Gold Trust (GLD)

Weighing in at $68 billion in total assets, GLD is not only one of the largest ETFs in the world, but it is one of the largest funds in the investing universe. This fund tracks physical gold bullion, allowing it to avoid the setbacks that are often featured in a futures-based product. The fund is highly active from a trading perspective and has a healthy options market for those who understand the complexities behind those contracts. But GLD’s biggest setback comes from its expense ratio of 40 basis points; while this isn’t high relative to the overall industry, it has been significantly undercut by a smaller product [see also Three Reasons Why Gold Is Overvalued].

iShares’ COMEX Gold Trust (IAU) also offers near-identical exposure to physical gold bullion, but does it at 15 basis points less than GLD, charging just 0.25% for investment. Think that number sounds insignificant? Consider two different million dollar portfolios, one which is wholly invested in GLD and the other doing the same for IAU (obviously a diversification nightmare but stick with me). The GLD portfolio will incur annual expenses of $4,000, while its competitor will shell out only $2,500. That $1,500 difference seems miniscule for just one year, but drag it out over a 30 year investment and the difference between fees amounts to $45,000, or 4.5% of your original investment. Saving yourself a quick 4.5% could have been as simple as buying IAU over GLD [for further reading, see Why No Investor Should Own GLD].

Dow Jones-UBS Commodity Index TR ETN (DJP)

This ETN is one of the most popular broad commodity ETPs in the world, as it offers exposure to a diversified basket of futures contracts. Unfortunately, DJP’s roll strategy makes it a prime target for contango. Contango, for those unfamiliar with the phenomenon, is simply the process whereby near month futures are cheaper than those expiring further into the future, creating an upward sloping curve for future prices over time. When an ETN like DJP executes a front month roll strategy, it is forced to sell out of its current contract and buy the next month’s contract. In a contagoed environment, that forces the fund to sell low and buy high, instantly erasing value for a portfolio [see also 12 High-Yielding Commodities For 2012].

Despite its massive $2.4 billion in size, there is another ETF that presents a strong alternative to DJP. The United States Commodity Index Fund (USCI) has been nicknamed the “contango killer” commodity product and has been outperforming DJP as of late. USCI isn’t actively managed, but rather seeks to replicate the performance of a commodity benchmark that rebalances monthly based on various pricing factors. Essentially, the fund attempts to find the most backwardated futures to invest in for the next month, erasing the front month roll issues. USCI currently has around $410 million in assets, but its strategy demands a closer look when it comes time to make your commodity allocation [see more on USCI at Closer Look At The “Contango Killer” Commodity ETF].

FTSE China 25 Index Fund (FXI)

Launched in 2004, FXI is easily the largest China ETF in the space, with more than three times the assets of the next biggest fund that focuses its assets on the emerging market. By debuting roughly eight years ago, FXI has been able to get a jump on the market, though its underlying holdings leave much to be desired. For starters, the fund holds only 27 securities, with nearly two-thirds of total assets dedicated to the top ten holdings. This means that just a handful of firms will guide the performance of the fund due to its poor diversification. The fund also overweights the financial services sector, skimming out on a number of other important market segments [see also BRIC ETFs And Missed Opportunity].

For a better play on the Chinese economy, investors would be better served with SPDR S&P China ETF (GXC). This fund features much better diversity, with over 170 total securities and the top ten holdings accounting for 46% of the total fund. While this is still a bit top-heavy, the exposure is much more diversified than FXI. GXC also holds financial services in high regard, but it does a much better job of hitting smaller market segments. Not convinced that this smaller player can outperform its massive competitor? GXC has a stronger 3 year, 1 year, and year-to-date return than FXI; and all of this comes with an expense ratio that is 13 basis points cheaper than its larger counterpart.

Disclosure: No positions at time of writing.