Given that ETFs are diverse in nature and low cost. How does one evaluate an ETF if its a good? What tools should you use and what should we be looking at in the quote? - Seedly
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Anonymous

Asked on 31 Jan 2019

Given that ETFs are diverse in nature and low cost. How does one evaluate an ETF if its a good? What tools should you use and what should we be looking at in the quote?

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Harvey Tan
Harvey Tan
Level 6. Master
Answered on 25 May 2019

In general, you should be looking at :

Mornningstar did a study few years back on fund fees in relation to performance.

In short, the cheapest funds perforrm the best.

Please do not take my statement at face value and do your research

https://www.morningstar.com/articles/752485/fund-fees-predict-future-success-or-failure.html

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There are numerous studies that show that the most consistent performer has two components:

  1. Fees, fees, fees.

Fees form a huge part of underperformance. Much of the mediocre return generated by mutual fund and other "alternative" ETFs are attributed toward higher cost structures.

Frictional costs are what contribute to mediocrity in most cases.

A very recent study on this, search "The Tax Benefits of Sepearting Alpha From Beta" shows that a ETF with tilt toward a particular strategy requires an additional alpha of 2.7% just to breakeven from a passively held low cost ETF fund.

  1. Inconsistency in consistency

Often, an investment goal is derailed due to factors such as psyche and emotions. I have had clients who decided not to stick to their "passive" investments largely because they "believe" they could outsmart and time markets. The very dangerous path to this is that for the vast majority of people, we just simply do not possess the crystal ball skill to determine what will happen the next week or month.

Even on a valuation standpoint, buying an undervalued asset requires stubborness to see through years of underperformance because you are right but the market is wrong. Even Graham chose to buy "diversified" holdings of under valued companies because the undervaluation of asset could last far longer than your emotional psyche could wait.

You cannot be both successful and delusional.

Watch out for fees, stick to a strategy which you can consistently apply, and be patient.

Click here to find out more about me!

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Frankie Rappaport
Frankie Rappaport
Top Contributor

Top Contributor (Jul)

Level 9. God of Wisdom
Updated on 17 Feb 2020

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SW
Shaun WQ Lim
Level 7. Grand Master
Answered on 08 Dec 2019
  1. Fees

  2. Composition of the ETFs i.e. number of stocks from the tracker index

  3. Weightage of the component stocks i.e. equal weight or by size/value.

  4. Alignment with your investment strategy i.e. markets you want to invest in

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Wilson Nid A Break
Wilson Nid A Break
Level 9. God of Wisdom
Answered on 08 Dec 2019

For index ETFs, just simply looked at their respective historical performance since the financial crisis 2008. A rule of thumb for me is that if till date the index had not recovered/exceed the pre-crisis drop levels, best to avoid it. Its a sign that the component stocks that constitue the index just aint dynamic and vibrant enough to shrug off setbacks

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ETFs have been a growth area in the investment arena for last few years so answer is by nature a little complex. Will try best to break down the different considerations as much as possible.

First, important overall thing to keep in mind - for the traditional ETFs (those that track an index), the purpose is a vehicle to allow you to express a certain investment view. So suppose there is a Gold ETF with zero fees, able to track gold price perfectly. If gold price tanks and so would the ETF price. But this is a (dreamland perfect) GREAT ETF manager! You have to seperate the manager performance from the impact of the investment view.

Now for traditional ETFs, key measures of the "goodness" of the manager would be fees and tracking error. Seperately on investor level - you may also consider the domcile for tax reasons.

For fees - depends a bit on the underlying investment mandate. For very standard indicies/instruments (eg S&P500 / Gold price) the fees can be very low - less than 10 basis points; it is fairly easy to set up a relicating portfolio and no clever work needed. For more exotic indicies or bond ETFs (which may have indicies which are hard/impossible to replicate) then there is more work needed when building the portfolio composition and use of derivatives to make up for less-than-perfect replication - so the fees may be higher; as a guide anything up to about 0.7% isn't impossible (but really depends on complexity; the upper end is rare and only for really customized indicies).

Tracking error - so fees are low (hopefully!) but then cheap can be crap right? how do you measure goodness? That is where tracking error comes in. An ETF would have a stated mandate (eg replicate the returns of S&P500 as a simple example). A key measure of the success would be how well they achieve the exposure that they said they will give you (which you have hopefully incorporated in your overall investment asset allocation) and this is measured by tracking error. You want low tracking error as it mean the manager is doing a good job. Again for widely held "famous" indicies this is easier than for bespoke indicies - so make sure you are comparing similar ETFs (eg SPY vs. VOO vs. VTI).

Domicile - this one is a bit out of manager control; but a consideration from investor level - US domiciled ETFs are subject to withholding tax whereas (due to regulatory quirks) Ireland domiciled ETFs can get a tax break. While that helps the Irish ETFs, do keep in mind they are much less liquid (so you like pay more spreads to purchase) and tend to have higher fees.

That's it for the traditional ETF space; as I said, innovation in ETFs is high these days due to the ballooning AUM and investor interest - so there is active ETFs; this is an area of ongoing changes in regulation/approach (eg London SE and Italian SE are both owned by the same parent but have different approaches to managing active ETFs) - the considerations for those are quite different so out of scope this time - perhaps raise another query if of interest.

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Luke Ho
Luke Ho, Money Maverick at Money Maverick
Level 7. Grand Master
Answered on 02 Feb 2019

The one ETF everyone knows about is certainly not diverse in nature (The STI ETF). Consider the all-in cost including any account fees, trading fees, managing fees, rebalancing fees. Recognize that this is designed to be a long term decision.

Diversification should come across sectorally, not globally - meaning that it should be widespread across sectors like consumer staples, financials, tech, etc, not across countries like China, US, Malaysia, etc. Which is a little bit why the STI is a piece of gunk.

You could do much better than an ETF, but its your call.

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