Betterment Warns On Dangers Of Sector ETFs

Heavyweight robo adviser Betterment has hit out at sector exchange traded funds (ETFs), arguing they are not ideal passive tools for diversified portfolios as they are more expensive and have higher turnover. But European ETF providers have hit back, claiming these ETFs allow for more targeted exposure.

In a blog for ETF.com this week, Betterment investment analyst Ellie Lan wrote that sector ETFs “not only rack up more fees when it comes to expense ratio, internal fund turnover, and bid ask spread, but they also require more work when it comes to rebalancing”.

Higher Costs Both Sides Of The Pond

Lan pointed out that U.S. sector ETFs have a median expense ratio of 0.45 percent, whereas investors can access an S&P 500 ETF for as little as 0.05 percent annual fees.

Data acquired by ETF.com from Morningstar found that, among Europe-listed funds, the average general sector ETF is 0.46 percent (base currency of GBP) and 0.41 percent (denominated in euros). Again in Europe, investors could invest in mainstream equity markets for much lower fees.

Eric Wiegand, ETF strategist at Deutsche Asset & Wealth Management, responded: “Our sector ETFs on the Euro Stoxx 600 Index for example have a TER of 30 basis points. That’s very competitive for that type of exposure.” DeAWM also offers a Euro Stoxx 50 ETF for just 0.09 percent fees.

Why Higher Turnover Costs?

Lan said in the blog that turnover costs are often hidden and occur at both the ETF level and the portfolio level, and sector ETFs do incur higher turnover costs.

“At the fund level, funds that track broad indexes such as the [U.S.-listed ETF] Wilshire 5000, which has more than 5,000 companies as constituents, will see less turnover than a sector ETF because of its stricter constraints and the higher hurdle required to meet each of the constraints,” she wrote.

James Polisson, chief marketing officer at Source, a major provider of sector ETFs, said: “[…] sector indices are more concentrated and less liquid than their parent benchmarks, so they can have higher trading costs. Investors should look for products that address these issues.” Polisson pointed to his own sector ETFs which he said are designed to avoid overconcentration and improve liquidity.

Each Has Their Place

Antoine Lesne, head of ETF sales strategy, EMEA at State Street Global Advisors, said Betterment’s claims are “not necessarily well founded”. He said sector ETFs, by definition, will only contain a subset of stocks from a parent index and will therefore be more volatile.

“By using sector ETFs, investor can potentially benefit from performance dispersion and the different roles they play in the portfolio. As such we believe the comparison [with broad equity ETFs] is not necessarily very relevant,” he said.

Across GBP and EUR-denominated funds, Europe offers investors a total of 628 sector ETFs, according to Morningstar, out of over 1400 ETFs listed in the region.

A statement from a spokesman at iShares added that sector ETFs “definitely have a place”.

“The objective of sector ETFs is to allow investors to become more granular with their equity exposures,” he said.