By Christian Magoon
CEO, Magoon Capital
Much has been made about recent expense ratio cuts by several major ETF providers. While it is true that these competitive moves benefit investors, the focus on lower fees can overshadow several other important factors that make ETFs desirable including access, transparency and diversification. Together these factors are increasingly appealing to a broader group of investors who are reassessing their use of mutual funds and even stocks. Here's a review of these three factors and their positive impact on investors.
ETFs provide access to a wide variety of investment strategies and asset classes that mutual funds do not. This is because an ETF can utilize several underlying operating structures that allow for more flexibility of holdings. For example, an ETF can be structured as a grantor trust, which allows it to hold assets not considered securities like bars of gold. Mutual funds do not have the ability to own assets that are not considered securities.
Besides providing access to asset classes, ETFs often provide more convenient access to many types of investments. For those interested in agricultural commodities for example, one can fill out the appropriate paperwork to become eligible to invest and trade in futures. Conversely an order can be placed for an ETF that owns specific futures or a basket of futures in the same time it takes to purchase a stock. ETFs ability to both access investments and to do so in an efficient manner, help to democratize the markets for all investors by overcoming many barriers of entry.
Whether you need to know how much Facebook (FB), Google (GOOG) or BP (BP) your portfolio holds, the majority of ETFs provide complete daily transparency of holdings. This stands in contrast to mutual funds which are only required to reveal their holdings once a quarter. Quarterly fund updates of exactly where your assets are invested seems out of date given the pace of today's markets. Indeed many remember rushing to understand their exposure to BP Amoco during the Gulf of Mexico oil spill a few years ago. ETF investors were able to know how much of the stock was contained in their fund based on the previous night's close. Mutual fund investors could find the exposure information but based off the most recent quarterly update in most cases. This is just one example of why in today's world and markets, transparency is more important than ever and ETFs are delivering it.
Many former stock jockeys have joined the ETF movement for the diversification it provides. Like stocks, ETFs provide the intraday liquidity stock investors appreciate. Unlike stocks however, ETFs provide exposure to a basket of securities that can limit company specific business risk. In addition, the securities selected to be in the ETF have been qualified, most often by an index provider, by basic factors including liquidity and market capitalization. Many indexes tracked by ETFs go above this quantitative qualification and employ investment oriented criteria to select the basket of holdings. Together diversification, liquidity and selection produce an attractive alternative to individual stock investing. After all, its easier to be in the right market segment or sector than in the right stock.
While it is true that ETF ownership costs provide significant savings to investors, the whole truth is that ETFs offer far more benefits above and beyond cost savings. The benefits of access, convenience, transparency, diversification and selection criteria cannot be ignored. So remember to consider all these factors - not just expense ratio - the next time your are selecting or comparing an ETF.