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Index Changes and Even More ETF Fee Competition

Be careful what you pay for. Cheap ETFs don't always perform the same as more expensive ones.

ETFs became even cheaper this week as JPMorgan launched a fund with the lowest expense ratio available and a smaller ETF provider plans to pay initial investors a small fee for putting money into one of their products. Yet, continuing a long-term and under-the-radar trend, asset managers also planned to change the indexes behind many existing ETFs. Since an ETF’s return is driven more by its holdings than its expense ratio, such changes warrant attention too.

Before we get to the index changes, let’s review the latest moves in an aggressive push to gather assets from investors focused on costs. JPMorgan BetaBuilders US Equity ETF (BBUS) launched on March 12 with $25 million in assets, but more importantly a miniscule 0.02 percent expense ratio. This is slightly below the prior low level offered by a handful of ETFs including the newly cheap $100 billion Vanguard 500 Index ETF (VOO) and the $19 billion iShares Core S&P Total US Stock Market ETF (ITOT). JPMorgan has quickly gathered assets with its well-diversified, single-country products such as the $3.3 billion JPMorgan BetaBuilders Japan (BBJP) that charges 0.19 percent and will first turn one year old in June. For perspective, the $15 billion iShares MSCI Japan (EWJ) charges 0.47 percent.

While every basis point of savings is notable, what is more important is cheap ETFs do not always perform the same because they don’t own the same securities. Indeed, ITOT’s 12.32 percent year-to-date gain as of March 12, 52 basis points ahead of VOO’s 11.8 percent, highlights a focus on what’s inside.

Meanwhile, we are waiting for the first two zero-fee ETFs from SoFi to come to market in the coming months. SoFi is waiving the 0.19 percent fee for at least the first year of operations and CFRA expects the waiver to be maintained for longer.

However, for a soon-to-be launched Salt Low truBeta US Market ETF, Salt Financial plans to waive the full 0.29 percent management fee and contribute 0.05 percent to the fund’s average daily net assets on the first $100 million in assets until April 2020. It can be a challenge for asset managers to reach the $100 million mark with a new ETF, used by some for screening or due diligence purposes, so rewarding the initial investors with a rebate could be enticing. Indeed, Salt High truBeta US Market ETF (SLT) charges the full 0.29 percent and has $11 million in assets despite being 10 months old and being slightly older than BBJP.

While the JPMorgan and Salt news garnered significant media attention, there was less focus this week that Invesco plans to change the indexes in the coming months behind 10 of its existing ETFs, and First Trust is shifting benchmarks for one of its own. Rather than shutting down one fund and launching a new one, such changes can make sense for an asset manager looking to realign its lineup to reflect shifting investor demands.

Yet, index changes are more common than investors likely realize, with 66 exchange traded products making a change in the three-year period ended 2018, according to ETF.com. For many of these, as well as the latest ones announced in March, the products have limited assets and trading volume, limiting the investor impact. However, for those that rely on a fund’s track record more than what CFRA recommends, it is important to note that the record moves forward even as the exposure is different.

For example, in June, Invesco Russell MidCap Equal Weight (EQWM), a $24 million ETF, will be renamed Invesco S&P MidCap Quality ETF (XMHQ) and track a mid-cap quality index. Given the popularity of the $1.4 billion Invesco S&P 500 Quality ETF (SPHQ) and growing investor focus on stocks with strong return on equity and low debt leverage traits, it is understandable for Invesco to shift benchmarks. 

Yet, the records for EQWM and its pending benchmark are quite different. For example, S&P MidCap 400 Quality Index declined just 3.6 percent in 2018, significantly outperforming the 9.1 percent loss generated by EQWM. But in 2017, the existing ETF’s 15.6 percent return was more than 200 basis points stronger than its new index.

From an exposure perspective, investors should expect significantly more financials going forward (24 percent of the new benchmark vs. 6 percent currently for the ETF) and consumer discretionary (20 percent vs. 9 percent) and less in consumer staples (4 percent vs. 10 percent) and materials (3 percent vs. 9 percent).     

Other Invesco ETFs shifting indexes include the $200 million Invesco India ETF (PIN) and the $70 million Invesco Russell 2000 Pure Value ETF (PXSV).

Meanwhile, in May First Trust will be changing the name, ticker and tracking index behind its $15 million First Trust NASDAQ Smartphone Index ETF (FONE). The pending First Trust Index NextG ETF will trade under NXTG and track a benchmark holding up to 100 securities that have devoted or have committed to devoting material resources to the R&D and application of 5G cellular technologies. 

CFRA Equity Analyst Keith Snyder notes that 5G networks promise new and improved features over current 4G LTE networks, such as faster download speeds, reliable low latency connections and the ability to support a massive number of connections. He highlighted projections from IDC that spending on 5G radio access network equipment alone is likely to expand from $300 million in 2018 to $13 billion in 2022.

The current index FONE tracks has a 45 percent weighting in handsets companies, 45 percent to Software Applications and Hardware Components and 10 percent to Wireless Network Providers. The ETF currently has approximately two-thirds of the assets in companies domiciled outside of the U.S. 

According to SEC filings, 80 percent of the new index will focus on data center and cell tower REITs, equipment manufacturers, network testing companies, mobile phone manufacturers, while 20 percent will be allocated to telecom services providers. Specific constituent data was not available to CFRA, but it is clear to us that there will be differences in what’s inside and ultimately performance.    

First Trust is not alone in focusing on 5G as last week, Defiance Next Gen Connectivity ETF (FIVG) launched to tap into investor interest in 5G technologies. The ETF tracks a BlueStar index that had more than 75 percent of assets in U.S. companies and a significant focus on radio access network equipment companies. It is too soon to determine how FIVG and NXTG will compare, but historically there are notable differences in the exposure thematic ETFs provide and their records. 

For example, First Trust NASDAQ Cybersecurity ETF (CIBR) rose 1.5 percent in 2018 but lagged its similarly named peer ETFMG Prime Cyber Security (HACK). HACK has more exposure to systems software companies and less in aerospace & defense ones. 

This article was originally published on March 13, 2019 on MarketScope Advisor. Visit www.cfraresearch.com for more details.

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