Understanding ETF Investing

Exchange-traded funds (ETFs) have become very popular, but it’s likely that many investors in ETFs don’t really understand what they own. This article highlights some characteristics of ETFs that likely elude many investors and explains how to evaluate ETFs and decide on their place in a portfolio.

A straightforward example of this comes from the world of high-yield ETFs. Lisa Abramowicz noted this summer that the SPDR Bloomberg Barclays High Yield Bond ETF, trading under the ticker JNK, underperformed its benchmark by an average of 1.69% for the three years preceding her 18 August 2017 column. Rival fund BlackRock’s iShares iBoxx USD High Yield Corporate Bond ETF (HYG)’s three-year average underperformance of 0.79% seems like alpha by comparison.

It’s understandable that there would be a difference between the performance of an index and the vehicles designed to track it. Even when their objective is just to replicate an index, investment vehicles come with costs that are not always explicit. A 2013 exploration of these issues from Morningstar found that funds generally did a good job limiting tracking error, but also pointed to interesting issues. The weekly error for ETFs tracking the MSCI Emerging Markets Index, for instance, ranged from 0.04% to 1.5%.