Reasons To Love Transparent ETFs

Reasons To Love Transparent ETFs

Trial by fire is one way to discover why ETF transparency matters.

ElisabethKashner_200x200.png
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Director of Research
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Reviewed by: Elisabeth Kashner
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Edited by: Elisabeth Kashner

Trial by fire is one way to discover why ETF transparency matters.

I would never be in the ETF industry if not for the crash of 2008 and a fellow named George.

George—as in the chief executive officer of Contango Capital Advisors—hired me when I completed my master's degree. I started in August 2008. You know what happened next.

With the crash in full swing, Contango's portfolio of—purportedly—defensive mutual funds failed spectacularly. The managers George had vetted did not cash out ahead of time, nor did they position their portfolios for free fall. Quite the contrary—several of them lost more than their benchmarks did. From an advisory perspective, the game had changed. We owed our clients in-house, pro-active due diligence.

George wanted to be able to assess risk in his portfolios, using holdings. Since he was predicting a slew of corporate bankruptcies, he wanted to build a portfolio of firms with solid balance sheets. The corporate bankruptcies never materialized, but what I learned in building George's new portfolio turned me into a transparency zealot.

Mutual fund disclosure policies blocked my efforts to find up-to-date portfolios. In October 2008, most mutual fund websites were presenting holdings as of June 30, 2008. Portfolios suffered redemptions and panic-selling following the Lehman collapse.

I could not expect June's data to apply to the post-crash world.

September's portfolio would appear after Thanksgiving. Mutual fund issuers follow Securities and Exchange Commission requirements to post quarterly holdings disclosures, within 60 days of quarter's end. In those days, 60 days was an eternity. With all the chaos, a portfolio could turn over twice in that time.

By comparison, exchange-traded funds delivered transparency daily, often in analyst-friendly spreadsheets.

Bloomberg provided security-level metrics like debt/equity ratios and quick ratios. Once I layered in some cumulative probability of default metrics, I could assess the credit risk of equity and fixed-income ETFs.

With holdings transparency and timely security-level data, George could reclaim his fiduciary role, and steer his clients into well-vetted ETF-based portfolios.

The work I did for George laid the cornerstone for ETF.com's Analytics service. I no longer run credit analyses on equity ETFs, but I am still a huge advocate of transparency. Daily disclosure means I can compare funds in real time, across the board. Portfolios are more stable than they were in 2008, but they are not static. Sometimes timing really matters.

The U.S. telecommunications sector has plenty of action these days. If you listen to ETF.com's morning call, you can confirm that we have recently discussed the Comcast–Time Warner merger and Netflix's efforts to break down net neutrality. To cut back to the chase, Telecom is a dynamic sector these days. Transparency lets us do timely analyses like this:

Equity: US Telecoms Fit Summary

Ticker WeightingSelectionGoodness of Fit R2BetaAverage Market CapP/EP/BDiv YieldNumber of HoldingsNote
VOXVanguard Telecommunication ServicesMarket CapMarket Cap0.800.85$68.45 B159.192.993.38%32Best pure play
IYZiShares U.S. TelecommunicationsMarket CapMarket Cap0.530.77$42.25 B-16.732.503.11%25Poor Fit to benchmark
XTLSPDR S&P TelecomProprietaryProprietary0.310.63$16.0 B-12.432.341.22%56Small tilt, big industry deviations
FCOMFidelity MSCI Telecommunication ServicesMarket CapMarket Cap0.790.81$68.18 B273.303.033.37%32Representative

Ranked by Fit Score

 

A timely apples-to-apples view reveals key facts, including negative trailing 12-month price/earnings multiples (PEs) and a wide dispersion of portfolio yields.

With challenges to net neutrality, it's useful to see that XTL—the SPDR S&P Telecom ETF (XTL | B-16) is seriously underweight in wireless and in the big telcos, but overweight in networking.

Equity: US Telecoms Sector Breakdown

ETF Explainer: VWO

For a larger view, please click on the image above.

If I wanted to pull off a similar feat in the mutual fund space, I would be at a huge disadvantage. As an example, here are eight telecom funds, along with the most recent portfolio dates and turnover ratios from the issuer websites:

Fund NameTickerMost Recent Holdings DateTurnover% Turning Over In 60 Days
Fidelity Select TelecommunicationsFSTCX12/31/2013118%19%
Fidelity Select WirelessFWRLX12/31/2013112%18%
Gamco Global TelecommunicationsGABTX9/30/20132%0%
T. Rowe Price Media & TelecommunicationsPRMTX12/31/201348.3%8%
Rydex TelecommunicationsRYTLXToday1550%255%
DWS Communications ATISHX12/31/201373%12%
Putnam Global Telecommunications FundPGBZX12/31/201363%10%
Wireless FundWIREX9/30/201316%3%

 

 

 

At best, I can compare five of them. WIREX and GABTX are stuck in September, and RYMIX, with daily transparency, doesn't yet provide a Dec. 31, 2013 look-back.

The telecom industry is changing every day. With an annual turnover of 118 percent, FSTCX could well have turned over 19 percent of its portfolio since the end of 2013. How can a fiduciary keep up?

A few weeks ago, when news that Puerto Rico's debt was downgraded to junk status first hit the tape, any ETF investor who feared a hit—or saw an opportunity—had ample tools to assess each ETF portfolio.

Mutual fund muni investors meanwhile have to wait until the end of April to find out if their managers saw it coming. They might never know if, for example, muni managers sell their Puerto Rico bonds before March 30.

There is a morality play in rehearsals at the SEC, in which sponsors of actively managed mutual funds are pushing for approval of nontransparent ETFs.

With huge advertising budgets, issuers will no doubt convince many to choose nontransparent ETFs.

Nontransparent ETFs might suit fund issuers, but they're bad for investors, because they take away a key tool for understanding a fund. They also could be very costly to trade, but that's another matter.

Front-running and copycat portfolios are the typical reasons given for delayed disclosure. Proponents of nontransparency claim that disclosure has a cost. I plan to take up the merits of that position in an upcoming blog.

ETF.com offers a look into equity fund holdings on a monthly basis, updated as soon as our contracts allow—generally five business days. I have pondered adapting the Analytics service to accommodate late disclosure if the SEC should approve nontransparent active ETFs.

But none of my options allows me to compare all funds at the same time, unless I'm willing to delay all equity reports by 60 days, and update them only four times per year. How can Analytics serve fiduciaries if we cannot provide timely portfolio information?

 


 

At the time this article was written, the author held no positions in the security mentioned. Contact Elisabeth Kashner at [email protected].

 

Elisabeth Kashner is FactSet's director of ETF research. She is responsible for the methodology powering FactSet's Analytics system, providing leadership in data quality, investment analysis and ETF classification. Kashner also serves as co-head of the San Francisco chapter of Women in ETFs.