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There are a ton of reasons why equity exchange-traded funds (ETFs) are one of the fastest-growing investment vehicles. Cost is the most often-cited benefit. ETFs like the S&P Depository Receipts (SPY) boasts an annual expense ratio of 0.10%, a fraction of the 1.50% that the average actively-managed large-cap fund charges. The nearly impossible task of beating the market means that stock ETFs are almost always better performers as well. ETFs have rewarded long-term shareholders with virtually no capital gains exposure, to boot.
Bond ETFs are another story. Although they’re cheap to own, there are a number of open-ended mutual funds that are actually less expensive to own than, say, the Lehman Aggregate (AGG) or the iShares Lehman 7-10 yr Treasury ETF (IEF). Interest payments and short-term gains associated with bond investing put traditional bond funds and ETFs on much more level playing ground as well.
But the argument against bond ETFs comes full-circle when one considers performance. In the ten-year period ending in 1997, none of the actively managed intermediate bond funds outpaced the Lehman Aggregate Bond Index. In the next ten-year period, less than 10% of the funds were able to outgun the index.
The odds of an investor finding just the right active fund are so low it’s not worth the effort. The energy is better spent on figuring out the right asset allocation, which ends up being a much more important decision in long-term wealth creation.
Ben Warwick is CIO of Memphis-based Sovereign Wealth Management.
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