ETF’s are one of the most popular investment securities in the market. The are easy to buy in and out of, while providing liquidity to investors to get a fair transaction price.
One way ETF managers make money is by charging an expense ratio to all holders of the ETF. An example would be the SPY ETF, which provides a proxy to invest into the S&P 500. The SPY charges 0.0009% “9 basis points “expense ratio, or 9 hundredths of one percent to all holders of the ETF. If you owned $100,000 of the SPY for a period of one year, your annual fee would be $90 dollars. The SPY and generally SPIDER, Vanguard and Fidelity have ETFs that charge extremely low fees and are regarded as the best investment vehicles in the market because of liquidity and their passive investment component.
There are also specialty ETFs in the market that have a sector, country, or thesis specific investment mandate. One specific ETF that invests in companies performing BuyBacks is listed under the ticker (PKW). This ETF is designed to mirror the NASDAQ US BuyBack Achievers™ Index (Index) and is managed by Invesco. The expense ratio is 0.63%, or $630 dollars for a $100,000 portfolio invested over the course of a year. As of 7/2/2019, the top 5 ETF holdings are Citigroup (NYSE: C), Oracle (ORCL), Apple (NASDAQ: AAPL), Cisco (NASDAQ: CSCO) and Union Pacific (NYSE: UNP), with portfolio weightings of 5.35%, 5.04%, 4.95%, 4.82% and 4.60% respectively. This means 24.76% of the entire ETF is invested between 5 stocks. This level of portfolio concentration can cause risk to invested funds because these stocks “pull” the entire index up or down.
Sometimes investing in specialty ETFs costs more than to manage a similar strategy yourself. We make this judgement based on the expense ratio, the level of active management in the ETF and what the investment objective is for the ETF. For a simple index ETF such as the SPY, you can’t mirror a strategy of investing in the S&P 500 for less than 0.0009% “9 basis points“… So you would be better buying the SPY ETF. On the other hand, with an ETF such as the PKW investing nearly a quarter of holdings in 5 stocks and charging 0.006%, “60 basis points“, you would be better creating a similar portfolio based on the holdings of the ETF.
Instead of investing in the PKW ETF, you could purchase the top 5 holdings for a fraction of the cost of the entire index and weight them 25% in your personal or professional portfolio. While the portfolio won’t follow the NASDAQ US BuyBack Achievers™ Index (Index) and lose the diversification of the rest of the 75% of the index, it will have a general bias to track similar. If you invested 25% of your portfolio in the 5 stocks listed above, the cost of ownership would be whatever your broker charges to buy and sell, or $10 dollars total if you use Interactive Brokers. The cost of individual stock ownership ($10) is significantly lower compared to the ($157.50) Invesco wants to charge for owning their ETF. I calculated the $157.50 by dividing the annual $630 fee by 4, or 1/4th of the portfolio being invested in the top 5 stocks.
The performance says it all, everyone of the top 5 holdings outperformed the PWK ETF over the last 5 years, by a significant margin. The PWK may provide diversification in a down market and it could reduce longer term investment risks when we exit this historical bull market.