Investors have three options, depending on their cost preference
The fund-of-funds model isn’t new in the financial industry. Just as there are now ETFs of ETFs being released, some mutual funds are financial nesting dolls, with at least part of their holdings invested in other mutual funds.
However, such products tend to cost more than those that directly hold securities and other financial assets. Citing Morningstar, a report by Money magazine said that the average ETF of ETFs has an expense ratio of 0.68%, compared to 0.24% for straight ETFs. With that in mind, those seeking to invest through ETFs of ETFs have different options.
Investors could avoid the cost altogether by trying to replicate the holdings of such nested ETFs themselves. Since most ETFs disclose their holdings daily, one can look under the hood of a profitable fund and try to figure out which bets it thinks are best without actually investing in it.
They can also choose low-cost options, which are usually the ETFs that invest in a diversified basket of broad asset-class ETFs. Since they compete with low-cost asset-allocation funds, they have to be cheap as well. Also, broad-based ETFs tend to be cost-effective vehicles.
As an example, the Money report cited a balanced ETF that holds ETFs of US stocks, foreign equities, and bonds. “The fund has beaten 60% of its peers over the past five years, and charges just 0.25% in expenses,” the article said.
Finally, investors can also buy ETFs of ETFs that have more specialized investing strategies. These funds are focused on specific rules, sectors, or objectives. Run right, they could get better returns than more broad-based strategies.
But they tend to be more costly. Money described how one fund provider has an ETF invested in other in-house ETFs. The nested fund invests in its five ETFs with the greatest momentum, with reviews and necessary reallocations done every two weeks. The downside is that it has an expense ratio of 0.89%.
The fund is also relatively risky, according to Todd Rosenbluth, senior director of ETF and mutual fund research at CFRA. According to Rosenbluth, its strategy based on market timing and its small number of holdings — selling just one could be a big jolt to the fund as a whole — should give investors a reason to think twice.
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However, such products tend to cost more than those that directly hold securities and other financial assets. Citing Morningstar, a report by Money magazine said that the average ETF of ETFs has an expense ratio of 0.68%, compared to 0.24% for straight ETFs. With that in mind, those seeking to invest through ETFs of ETFs have different options.
Investors could avoid the cost altogether by trying to replicate the holdings of such nested ETFs themselves. Since most ETFs disclose their holdings daily, one can look under the hood of a profitable fund and try to figure out which bets it thinks are best without actually investing in it.
They can also choose low-cost options, which are usually the ETFs that invest in a diversified basket of broad asset-class ETFs. Since they compete with low-cost asset-allocation funds, they have to be cheap as well. Also, broad-based ETFs tend to be cost-effective vehicles.
As an example, the Money report cited a balanced ETF that holds ETFs of US stocks, foreign equities, and bonds. “The fund has beaten 60% of its peers over the past five years, and charges just 0.25% in expenses,” the article said.
Finally, investors can also buy ETFs of ETFs that have more specialized investing strategies. These funds are focused on specific rules, sectors, or objectives. Run right, they could get better returns than more broad-based strategies.
But they tend to be more costly. Money described how one fund provider has an ETF invested in other in-house ETFs. The nested fund invests in its five ETFs with the greatest momentum, with reviews and necessary reallocations done every two weeks. The downside is that it has an expense ratio of 0.89%.
The fund is also relatively risky, according to Todd Rosenbluth, senior director of ETF and mutual fund research at CFRA. According to Rosenbluth, its strategy based on market timing and its small number of holdings — selling just one could be a big jolt to the fund as a whole — should give investors a reason to think twice.
For more of Wealth Professional's latest industry news, click here.
Related stories:
Most smart-beta ETFs performing worse than the market
Morningstar reports better investor returns from automatic savings plans
