Why Bigger Really Is Better For ETFs

March 23, 2016

According to FactSet data on ETF.com, $2.13 trillion was invested in 1,869 ETFs as of the March 15. How can you decide which is right for you?

One rule of thumb I embrace is that bigger is often better. Not only are bigger ETFs typically more liquid, they are better constructed.

The largest 100 ETFs have attracted nearly 75% of the assets, and the largest 10 alone have 27% of all ETF assets.

Four Common Traits

All of these funds have four things in common.

First, they all have low expense ratios. The simple average annualized expense ratio is 0.13%. Lower expenses correlate to higher investor returns.

Second, they are all relatively broad. For U.S. stocks, the Vanguard Total Stock Market (VTI | A-100) is about the broadest of all U.S. stock funds, while the three S&P 500 index funds are relatively broad. Though the growth of the PowerShares QQQ (QQQ | A-67) and the iShares Russell 1000 (IWF | A-91) is a bit narrower, they still own a large part of the U.S. stock market.

The international stock ETFs aren’t quite as broad as the Total International Stock Index, but by using the Vanguard FTSE Developed Markets (VEA | A-95) combined with the Vanguard FTSE Emerging Markets (VWO | B-93), you can approximate a total international stock fund. Finally, the iShares Core US Aggregate Bond (AGG | A-98) approximates the U.S. investment-grade taxable bond market.

Rank Fund Ticker AUM ($, as of
Jan. 31, 2016)
Annual
Exp Ratio
Individual
Share
Aggregate
Share
1 SPDR S&P 500 SPY 174,648,990,892 0.09% 9% 9%
2 iShares Core S&P 500 IVV 66,867,460,123 0.07% 3% 12%
3 iShares MSCI EAFE EFA 55,812,796,138 0.33% 3% 15%
4 Vanguard Total Stock Market VTI 53,634,668,483 0.05% 3% 17%
5 Vanguard 500 VOO 40,222,029,481 0.05% 2% 19%
6 PowerShares QQQ QQQ 37,824,114,218 0.20% 2% 21%
7 Vanguard FTSE Emerging Markets VWO 31,845,893,091 0.15% 2% 23%
8 iShares Core US Aggregate Bond AGG 31,731,883,589 0.08% 2% 24%
9 iShares Russell 1000 Growth IWF 28,522,042,261 0.20% 1% 26%
10 Vanguard FTSE Developed Markets VEA 28,024,002,480 0.09% 1% 27%
             

All Market Cap Weighted

Third, they are all market cap weighted; no equal weighting or fundamental indexes. Why? Because those funds are more expensive, less tax efficient and they have a smaller cap and value tilt. They cost more to manage, and trading means more pass-through of capital gains. It’s less expensive to construct a small-cap value tilt yourself (like owning a little extra small-cap value ETF) without tilted ETFs.

The last thing these large ETFs have going for them is that they are unlikely to be the hot performers. Only the very narrow specific funds can own this title, and they will often become the worst-performing ETFs.

My Take

I’m certainly not saying one should only invest in the largest of the ETFs, but that can be a general guide. And the biggest ETFs aren’t always the broadest. The SPDR Gold (GLD | A-100) was the largest ETF on the planet for a brief time in 2011. That was anything but broad.

However, if you are going to invest in an ETF that has only attracted a few million in assets (something like a levered natural gas ETF) thinking you know better, I would call it gambling with odds worse than Vegas.

Stick to big, broad and boring ETFs with ultra-low fees.

Allan Roth is founder of Wealth Logic LLC, an hourly based financial planning firm. He is required by law to note that his columns are not meant as specific investment advice. Roth also writes for the Wall Street Journal, AARP and Financial Planning magazine.

 

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