ETF Scary Monsters & Super Freaks

October 31, 2014

No need for the horror movies, these ETFs will keep you up all night.

I love Halloween. I live in a small New England town. Kids trick or treat in the dark, moving between jack-o-lantern-lit houses in amoebic packs of Harry Potters and vampires and Han Solos, scavenging loot from porches. It’s something out of Norman Rockwell. There’s even a parade to start off the night.

As an adult, the very best part of Halloween is costume judgment. We descend on a friend’s house in one of the hot trick-or-treating neighborhoods, and sit on the porch with a glass of wine deciding which kids have made the effort worthy of a full-sized candy bar, and which kids are getting popcorn in plastic bags.

In other words, it’s exactly like my day job.

There are certain archetypes in judging costumes, just like there are with ETFs, so without further ado, the scary monsters of an ETF Halloween …

Zombies

For a good five years, zombies have dominated the local trick or treating scene. The makeup’s easy, and you can just tear up some old clothes and mumble “brains…” a lot.

In the ETF world, we’ve got more than our share of undead who, while slow moving, will kill the unwary. Funds that were dead a long time ago, they just refuse to recognize it and stay buried.

The winner here, of course, is the worst ETF in the world, the Elements Linked to Spectrum Large Cap U.S. Momentum ETN (EEH). Since I pointed it out in September, it’s continued to trade a few thousand shares a day. It closed yesterday at $31.95, just a smidge over its fair value of … $14.76.

It just won’t die, and it’s slowly eating somebody’s brain, a few thousand shares at a time.

Vampires

Vampires all but disappeared from the yearly Halloween parade until the double-whammy combo of the sparkly kind from Twilight, and the heavy metal kind from David Tennant’s excellent Fright Night Reboot kicked them back into high gear a few years ago (seriously, it’s a masterpiece).

But the vampires of the ETF world have never gone out of style. There are whole sectors of the ETF market that just slowly suck the blood out of investors with higher fees or surprise expenses.

The most notable class of these vampires is definitely the MLP funds, specifically those who have chosen to organize as traditional corporations. Those funds have to pay taxes internally, which balloon their headline expense ratios to, in some cases, 8 or 9 percent.

 

That’s right, 8 or 9 percent of your investment being bled out, year after year, to cover the internal taxes on the distributions from the underlying MLPs.

The C-Corp MLPs aren’t alone in having structural issues that turn them into bloodsuckers. The alternatives space is full of ETFs that take short positions and have to pay dividends out to those short positions.

But the real winner in my book is small funds that simply choose to not waive any expenses, passing the full costs of being small onto investors. The winner here is the Teucrium Soybeans ETF (SOYB), which has a straight-up cost, no fooling, of 3.97 percent. If that’s not insulting enough, in its worst one-year period, it actually trailed its own index not by that 3.97 percent, but by 12.4 percent.

Bloodsucker indeed.

Disney Princesses

My only dread for Halloween is seeing the parade of young girls in Disney “Princess” dresses. I am quite sure that tonight the annual parade will include at least a dozen Elsas from Frozen (which, to be fair, was the best Disney musical in a long, long time.)

And there’s nothing wrong with that. I just so often look down at the girls, as I hand them a candy bar, and think, “I know you love Ariel/Elsa/Snow White, but there are so many cooler things out there you could pretend to be!”

The Disney princesses of the ETF world are all of those enormous ETFs that remain popular year after year, despite the fact there are cooler, better products sitting right next to them.

People love the SPDR S&P 500 (SPY | A-97), and they’re not wrong to love it, but they could do better—actually quite a bit better. SPY has a headline expense ratio of 9 basis points, but on a median year, it actually trails the S&P 500 by more like 17 bps. Compare this with the iShares S&P 500 ETF (IVV | A-97), which is not only 2 bps cheaper, it actually habitually stays on target, clocking in 7 bps behind the index with laserlike focus.

Even inside iShares, the princess problem persists. The iShares MSCI Emerging Markets ETF (EEM | B-97) still gets most of the love, with $36 billion in assets, despite the fact it’s enormously expensive compared to its own sister fund, the iShares Core MSCI Emerging Markets Fund (IEMG | B-99).

EEM charges a whopping 67 basis points in fees, versus 18 bps for IEMG. And IEMG is just objectively better run to boot, with a median tracking difference just 3 bps points off its index, versus 55 for EEM.

Beware the sparkly dress.

 

Teenagers In Hoodies

There’s one rule at our annual Halloween gathering. No costume = no candy. Yet year after year, groups of goofy teenagers will reluctantly slink up to the porch in jeans and hoodies and mumble “trick or treat” hoping to get a handout.

No dice. You want the candy? You can at least go get a Nixon mask and try your “I am not a crook” impression.

The ETF world has its share of funds that really shouldn’t get any candy from most investors as well.

Loyal readers will know what a huge fan I am of volatility funds like the iPath S&P 500 VIX Short-Term Futures ETN (VXX | A-47), and those funds have no real place in most portfolios. Ditto most leveraged and inverse products.

Watching The Parade

For the most part, the hometown costumer parade is full of well-meaning kids who cobble together something fun. The ETF space is the same—the vast majority of ETFs do what they say they’re going to do, and they do it well. But there’s good and bad everywhere, and it pays to keep an eye out for the scary monsters.


At the time this article was written, the author held no positions in the securities mentioned. You can reach Dave Nadig at [email protected], or on Twitter @DaveNadig.


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