ETF advantages over traditional mutual funds



|ETF advantages over traditional mutual funds | |

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|I'm sure this has been discussed in the past, but these nuances were new to me while listening to a conference call |

|sponsered by schwab about etf's: |

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|Advantages to using ETFs over traditional mutual funds: |

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|1) Many studies have been done by third parties to analyze the tracking of ETFs, and many times it has been shown that the|

|tracking is not as consistent as for traditional mutual funds, impacting overall returns. Often, these studies are flawed.|

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|a) for more heavily traded ETFs, the last trade is at 4:15. The NAV of the underlying indexes are calculated at 4:00 |

|prices. There will be a false discount or premium to NAV at the end of every day. |

|b) for less liquid ETFs, because the last trade sets the price of the ETF, it may be off by several hours or even days |

|from the 4:00 NAV pricing of the index. |

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|2) ETFs may be more efficient when indexes re-balance. This could be especially important with upcoming changes to many of|

|the most popular indexes. ETF's, unlike mutual funds, have the ability to sell low-cost basis shares first due to the |

|in-kind redemption process. Because the average cost basis will typically be much higher for an ETF, upon index re-balance|

|the ETF will trigger much fewer capital gains than would a traditional mutual fund. |

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|3) Vanguard 500 Index estimates there would have to be 70% (I'm not sure about this number, but the concept remains the |

|same) net redemptions before it would be forced to liquidate low cost basis stocks. Schwab S&P 500 Index estimates about |

|40%. This estimate may be significantly overstated because the tracking of the index must be maintained, so only a limited|

|selection of stocks can be sold to meet redemptions without effecting tracking. If a net sell-off of a particular mutual |

|fund were to occur, large capital gains might be created. Of course, ETF's creation/redemption structure would prevent |

|this. |

|Re: ETF advantages over traditional mutual funds | |

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|An interesting question which I have posted but not had anyone tackle is if a successful introduction of VIPERs would allow Vanguard's traditional |

|customers to reap some of the advantages of ETFs. |

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|Vanguard has claimed that VIPERs will simply be another class of share on the same pool of assets. If this is really true, then the arbitrage balancing|

|mechanism for VIPERs could be used to get rid of low basis shares in the combined fund -- meaning the conventional investors would have less of a |

|latent capital gains risk. |

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|I can't test any of the claims made by the speaker, but of course he is trying to sell ETFs . Iff they really think they can show flaws in the studies,|

|then they should publish their own study in a peer-reviewed journal. Otherwise, it is untestable marketing hype. |

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|Did he discuss any of the other potential drawbacks to ETFs: bid/ask spreads, dividend drag, dividend reinvestment difficulty, brokerage fees, or |

|tracking error (in other words, how well have the sponsors of ETFs been at avoiding it in the past)? |

|Re: ETF advantages over traditional mutual funds | |

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|At to the VIPERs, if they ever do come out, I would think the only cost of getting out of the Vanguard's mutual funds |

|(with relatively low basis, and assumed higher capital gains distributions) would be transaction charges and tax |

|liabilities. The question is if the actual internal tax benefits of ETFs are worth that cost, and how exactly can you |

|quantify that tax benefit. It will depend on the particular investor, their holdig period, brokerage fees, etc. I think |

|the jury will be out on this one for quite a while. (On this web-site, it seems to take at least 20 years for data to be |

|realiable!) By the way,instead of buying VIPERs, you could just as easily go to iShares, which track the same indexes for |

|many of Vanguard's mutual funds. |

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|As to the negatives of ETF's, the speaker did acknowledge that they some negatives do exist, but to what extent they |

|offset the tax benefits of ETF's, who really knows? |

|Re: ETF advantages over traditional mutual funds | |

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|According to the prospectus, Vanguard has structured VIPERS in such a manner that unitholders of their conventional index funds can switch to the |

|VIPERS class of the same fund with no adverse tax consequences. As I recall they even announced initially that the switch would be no cost, but later |

|decided to impose a nominal ($50?) fee. |

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|OTOH, if you switch to iShares or SSgA ETFs then there would be adverse tax consequences -- unless, of course, you bought the Vanguard funds in the |

|past year or so :-( |

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|Cheers...Bylo Selhi |

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