ETFs and Asset Allocation - Morningstar

[Pages:24]ETFs and Asset Allocation

Michael Rawson, CFA ETF Analyst michael.rawson@

? 2006 Morningstar, Inc. All rights reserved.

Increasing Acceptance of ETFs

"Anticipating that the U.S. Federal Reserve will resume large-scale purchases of U.S. Treasury bonds and confronted with strong domestic political pressure to spur growth and restrain a rising yen, the Japanese central bank launched a bond-buying program. It said it would spend 5 trillion yen ($60 billion) to buy government bonds, corporate IOUs, real-estate investment trust funds and exchangetraded funds--the latter two a departure from past."

From The Wall Street Journal 10/6/2010

? 2006 Morningstar, Inc. All rights reserved.

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Agenda

? Introduction to ETFs ? Overview of ETF Market ? ETFs vs. Mutual Funds ? Advantages and Disadvantages

? Asset Allocation ? Strategic ? Tactical

? Tactical Investing Ideas ? List of ETF Providers with a wide

selection of funds

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ETFs: A Growth Story

? Industry evolving beyond domestic equity ? Democratization of "difficult-to-access" asset classes

Source: Morningstar Direct Fund Flows

? 2006 Morningstar, Inc. All rights reserved.

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iShares leads, but Vanguard is gaining...

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Ten Largest ETFs

Fund

Ticker

Standard & Poor's Depositary Receipts SPDR Gold Trust iShares MSCI Emerging Markets Index Fund Vanguard Emerging Markets Stock Index iShares MSCI EAFE Index iShares S&P 500 Index PowerShares QQQ Trust iShares Barclays TIPS Bond iShares iBoxx $ Invest Grade Corp Bond Vanguard Total Stock Market Index Fund

SPY GLD EEM VWO EFA IVV QQQQ TIP LQD VTI

Total Net Assets (Billion)

78 55 45 36 35 23 22 20 15 15

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? 2006 Morningstar, Inc. All rights reserved.

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Funds with the Largest YTD Flows

Fund

Ticker

Vanguard Emerging Markets Stock Index SPDR Gold Trust PowerShares QQQ Trust iShares MSCI Emerging Markets Index Fund Vanguard Total Bond Market Index Fund

VWO GLD QQQQ EEM BND

Total Net Assets Billion

36 55 22 45 9

YTD Flows

13.3 6.9 2.6 2.5 2.3

Standard & Poor's Depositary Receipts

SPY

78

-8.8

PowerShares DB US Dollar Index Bullish

UUP

1

-2.5

iShares FTSE/Xinhua China 25 Index Fund

FXI

9

-1.5

Financial Select Sector SPDR

XLF

5

-1.5

SPDR Dow Jones Industrial Average ETF

DIA

8

-1.3

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What Are Exchange-Traded Funds?

? In a basic sense, most ETFs are investable indexes ? Low-cost and tax efficient investment vehicles ? Availability of myriad asset classes allows for efficient diversification

previously available only to large institutions ? Mutual Funds that trade like stocks...

? 2006 Morningstar, Inc. All rights reserved.

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What Are Exchange-Traded Funds? ? But...

? Listed on an Exchange like a stock or closed-end fund ? Traded Intraday ? Allow for stock-like strategies such as shorting and margin

investing.

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How A Mutual Fund Works

? 2006 Morningstar, Inc. All rights reserved.

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How an ETF differs from a Mutual or Closed-End Fund ETF Creation/Redemption ETF Provider

Securities

(In-kind transfer)

ETF Shares

Primary Market Secondary Market

Authorized Participant

Buyer

ETF Shares

Stock Exchange

Seller

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Advantages of ETFs ? Tax Advantage ? Cost ? Diversification ? Modularity

? Liquidity ? Immediate market execution ? Access to new investments ? Transparency

? 2006 Morningstar, Inc. All rights reserved.

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Potential Drawbacks of ETFs ? Transaction fees (typically smallest component of cost) ? Total Cost Analysis is Difficult ? How Much do AP's Make? ? Limitations within tax protected accounts (401K) ? In flat or down market, mutual funds perform well on tax basis

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Passive, Long-Term Investing: Lowest Cost Wins

Avg. Expense Ratio

1.4

1.2

1

0.8 ETFs

0.6

0.55

0.4

0.2

0

OE Index Funds 0.81

All OE MFs, 1.23

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? 2006 Morningstar, Inc. All rights reserved.

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Proliferation of Asset Classes

? In the beginning, ETFs only offered broad index and equity sector exposure

? Now, ETFs offer access to nearly every asset category imaginable ? Fixed Income ? Fundamental Indexes ? Commodities ? Currencies ? Target Date Strategies ? Leveraged Equity ? Hedge Fund Strategies ? Niche Sector Slicing

Broad Asset Class U.S. Stock International Stock Balanced Taxable Bond Municipal Bond Alternative Commodities

Total

# of ETFs 462 194 27 78 29 141 77 1,008

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Takeaways: ETFs versus mutual funds ? Execution more complicated than with a mutual fund

? Advantages can justify the effort and complexity

? Know what you own! Doing your homework means more than just reading the name of the ETF.

? 2006 Morningstar, Inc. All rights reserved.

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