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Fund Spy
4 ETFs to put in your toolbox
Exchange-traded funds are a nifty idea, but its easy for investors to make mistakes with them. Here are four ETFs Morningstar likes.
By Morningstar
As financial advisors and both institutional and individual investors have embraced exchange-traded funds (ETFs) with increasing enthusiasm in recent years, we've often played the part of the worrywart. We've pointed out how easy it is for investors to shoot themselves in the foot by trading too much, racking up transaction costs and betting on narrowly focused funds. Despite those misgivings, we really do like some ETFs.
ETFs do offer investors powerful alternatives in categories where there aren't many affordable mutual fund choices with good records. Other ETFs offer stiff competition to traditional core equity and fixed-income funds. Fund families such as Fidelity, E*Trade and USAA recently acknowledged as much by cutting their index fund fees.
In this column, we'll look at four useful ETFs. None of them get unqualified endorsements -- they all have their risks and caveats. And, as always, investors need to make sure ETFs make sense from a cost perspective and fit in their overall investment program before using them. The following ETFs, however, have utility.- iShares MSCI-Japan Index (EWJ, news, msgs)
The shortcomings of the Japan-stock fund category make this ETF worth a look. There are just a handful of traditional offerings in the group with long track records, and their risk/reward profiles are daunting: The typical Japan fund has fallen by double digits in five of the past 10 years. Many of those funds also have high expenses and have seen a lot of manager changes. Consequently, this fund's low-priced, diversified exposure to leading Japanese companies looks good. There are three index funds in the category with lower expenses than this one, but Vanguard Pacific Stock Index (VPACX) and TD Waterhouse Asian Index (TDASX) are not pure plays on Japan -- they include stocks from Australia, Hong Kong, and Singapore. iShares S&P/TOPIX 150 Index (ITF) provides similar exposure to Japan, but it isn't as big or as actively traded. Just a dab of this volatile fund will do you, but it may be your best bet if you're looking for quick, cheap Japanese exposure.
- Vanguard Total Stock Market VIPERs (VTI, news, msgs)
A price war has ratcheted up the competition in the large-blend category, but this fund remains an excellent way to own the entire domestic stock market in one package. It's the only ETF that tracks the Wilshire 5000 Index, which includes virtually every publicly traded stock in the United States. You also get access to Vanguard's Gus Sauter, who is renowned for using trading strategies at Vanguard's traditional index funds to reduce tracking error and sometimes boost returns -- only you get it in the cheaper, more tax-efficient ETF format. This fund isn't the cheapest large-blend ETF, and it isn't even the cheapest fund tracking the Wilshire 5000. However, there's no guarantee that rivals such as the Fidelity Spartan Total Market Index (FSTMX) fund will keep their recent fee waivers forever, or that they will be as deftly managed as this one.
- iShares Lehman Aggregate Bond (AGG, news, msgs)
This fund, which tries to track the Lehman Brothers Aggregate Bond Index, would be a good compliment to Vanguard Total Stock Market VIPERs in a simple, all-ETF portfolio. If there were an ETF version of Vanguard Total Bond Market Index (VBMFX), we'd probably recommend it because of the Vanguard fund's history of adroit execution. (The fund has rarely trailed the Lehman Aggregate by more than its expense ratio.) However, this ETF is currently the only one of its kind. It's still too young to assess its ability to track its benchmark, but it could ably fill the fixed-income slot in a low-maintenance portfolio.
- iShares Dow Jones Select Dividend Index (DVY, news, msgs)
This young fund probably isn't a core holding. It tracks an index of the 50 highest-dividend-yielding, non-REIT companies in the Dow Jones U.S. Total Market Index. Its concentrated on dividend-rich sectors, such as utilities, financials and consumer goods. Nevertheless it's an interesting, inexpensive way to add yield to an equity portfolio. Barclays Global Investors, iShares' advisor, rolled out this fund, in part, to take advantage of last year's corporate dividend tax cut, but it's still not a bad idea. If desultory prognostications for future equity returns come true, dividends will become a more important component of total returns.
Stat du jour
Of all the ETFs in the Barclays family, iShares MSCI EAFE Index (EFA, news, msgs) paid the most in management fees during the 2004 fiscal year, according to regulatory filings. It paid more than $18 million. iShares Russell 2000 Index (IWM, news, msgs) was second, paying $7.2 million in fees, and iShares S&P 500 Index (IVV, news, msgs) was third, paying $6.5 million.
Disclosure: Barclays Global Investors, which is owned by Barclays, currently licenses Morningstar's 16 style-based indexes for use in BGI's iShares exchange-traded funds. iShares are not sponsored, issued, or sold by Morningstar. Morningstar does not make any representation on the advisability of investing in iShares.
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