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Vanguard Splits ETFs For Mysterious Reasons

June 4, 2008

Vanguard Splits ETFs For Mysterious Reasons

Apparently Vanguard has been a little too successful in attracting smart, fee-conscious, long-term investors.

Its relatively new exchange-traded (ETF) fund lineup has achieved remarkable success, hitting $50 billion in assets - $8.5 billion came in so far in 2008 alone. So why is Vanguard messing with such a good thing, using gimmicks the firm wouldn't use with its traditional funds?

This article off the Dow Jones Newswire offers possible explanations including:

The effect of Vanguard's share split will be to allow investors to trade the funds in smaller amounts. For now, each of the three ETFs' share price is more than $100. Shares of Vanguard Total Stock Market ETF are about $138, meaning that's the de facto minimum investment for any investor who wants to buy the fund, and the smallest increment in which existing investors can buy and sell. After the split the new number will should closer to $69."

But investors with less than $100 should probably not be investing in ETFs at all. Even at a cheap discount broker an ETF investor is going to pay $7 in commissions - which is a big chunk of a sub-$100 ETF investment. That kind of cost runs counter to one of exchange traded funds' main selling points - their cheapness of ownership.

The only legitimate reason we can think of for Vanguard's split of ETF shares is to lower the bid/ask spread. The bid price is the highest offer to buy and what a seller would get selling an ETF (or stock). The ask price is the lowest price sellers are asking and the price at which an investor would buy (assuming you are trading a relatively small number of shares). This spread represents costs ETF investors would avoid by buying ordinary index funds which trade at NAV (net asset value) at the end of the day. For thinly-traded ETFs, such spreads can be 10 cents per share or more. Even for longer-term investors this hurts performance, as it represents .25% per share on a $40 ETF - much more than the expense savings between an ETF and an ordinary index fund.

Vanguard 's ETFs appeal primarily to longer-term investors who like the lower fees. Vanguard's largest ETF, Vanguard Total Stock Market ETF (VTI), has $10.4 Billion in assets, and trades about a half million shares a day. PowerShares QQQQ (QQQQ), one of the most popular ETFs with active traders, is about twice as large, but trades well over 100 million shares a day - more than 200x as much as Vanguard Total Stock Market. Because of this massive volume, spreads on QQQQs are often just a penny a share.

Vanguard tells us that they expect the trade volume of these split ETFs to double and the bid ask/spread to fall with the higher volume, but they do not expect the bid ask spread to fall by 50%. When asked how this is supposed to save fund investors money when they would be buying twice as many shares post-split as they would have pre-split for the same investment amount, I was told it was because the spread would be narrower. Go figure.

The real reason for the split is perhaps the same one publicly traded companies use when they split their shares - make the stock seem to have more upside and therefore more attractive to investors. Vanguard admits the psychological effect of the lower price was a factor. SPDR S&P 500 ETF (SPY) - the largest ETF with around $70 billion in assets - trades at around $138. We'll see if investors think VTI is more attractive than higher-priced ETFs at the new lower price after the June 17th split. If they do, then the volume of these funds will more than just double, and dramatically increased volume could result in far lower bid ask spreads.

But what if this leads other ETF providers to do 10 for 1 splits? We don't put it past the increasingly strange ETF business.


Dollar Up, Foreign Funds Down

May 28, 2008

The vast majority of investors think that the U.S. dollar will continue its multi-year decline. Why else would the fund industry be launching so many new currency ETFs?

As long time MAXfunds.com readers know, we think most investors are usually wrong (this is the main reason why fund investors as a group underperform the market). For the last couple of years fund investors have been flooding into foreign funds for their S&P 500 beating returns. Most investors probably don't understand that much of foreign-fund's outperformance is a result of the dollar's fall. Most investors should read this Wall Street Journal Article:

Foreign stock funds soared over the past seven years, far outpacing the returns of U.S.-focused funds. A big driver of the gains was the dollar's decline against foreign currencies.

Now the tide may be turning. Many market pros -- even longtime dollar bears, such as celebrated investor George Soros -- are betting that the dollar is stabilizing and may even go up in the next 12 to 18 months. For small investors, a stronger dollar could mean that many of the gains they've enjoyed in recent years in their foreign-stock funds could be imperiled."

Most shocking of all to those giddy over the past performance of funds like Dodge & Cox International (DODFX) - a fund we recommend here when it was brand spankin' new and has been on our favorite funds list since 2002 - is this nugget:

The MSCI EAFE index, a leading benchmark of developing-country stocks, had an 8.8% annualized total return in U.S. dollar terms between Jan. 1, 2001, and Dec. 31, 2007. In local-currency terms, the return was merely 4.3%."

One option for dollar bulls going forward (besides increasing allocations to U.S. funds) is to focus on foreign funds that hedge currency exposure. While these funds can be expensive and can reduce the diversification benefit of investing globally, with the current down-and-out buck they are a reasonable solution in the short term.

The WSJ article details several funds that are hedging currency fluctuations. Surprisingly, some funds that never did so are now hedging (traditionally funds either hedge or don't). According to the article, Dodge & Cox International Stock (DODFX) is hedging for the first time since its launch.

Whos Hot on the Dollar, Whos Not

Mostly Hedging:

Tweedy, Browne Global Value (TBGVX)
Longleaf Internatinonal (LLINX)
Mutual Series European (TEMIX)

Not Much Hedging:

Vanguard Developed Markets Index (VDMIX)
Fidelity International Discover (FIGRX)
American Funds EuroPacific Growth (AEPGX)

Increasing Hedging:

Oakmark International (OAKIX)
Dodge & Cox International Stock (DODFX)
Henderson International Opportunites (HFOAX)


ETFs vs. Mutual Funds - The Debate Continues

May 22, 2008

When you spend every waking hour for a decade working on a mutual fund investing website, you get a little cranky over fund-related innacuracies. We were so annoyed about that trader/gibberish panel discussion about exchange traded funds vs. mutual funds the other day we decided to make our own video about the very same subject. Sort of. Well, it's really just a segment on a business TV show about said topic. At a bar. Hey - we're not Morningstar or CNBC - we don't get to have a conference at a fancy hotel with thousands in attendance. Anyhoo, we're pretty sure MAXfunds.com co-founder Jonas Ferris hadn't had a drink before participating in this enlightening ETF discussion.


ETF or Fund Better? Depends Who You Ask...

May 20, 2008

An audience member at some sort of live CNBC event asks a seemingly simple question about exchange traded funds:

"For the small investor that wants to hold their investment for awhile and they are looking at a mutual fund verses an ETF and it's the same sector and it's the same kind of portfolio, why would you buy a mutual fund over an ETF given that the ETF usually has lower costs?"

...and in response gets day-trader mumbo jumbo from the expert panelists. The conclusion seems to be that ETFs are essentially always better because investors can buy and sell them intraday (so much for the 'small investor that wants to hold their investment for awhile' part), because the market gains big on some days and you don't want to miss those days.

Of course the market also falls big some days and investors would want to miss those days - and could benefit from ordinary open end funds which only execute investors' buy trades at the end of the day. For a longer-term investor, intra day price swings are irrelevant because those investors have no idea if the market is going down or up the day they buy in.

What is relevant is that ETFs can be cheaper to own, but can also be more expensive than similar open-end funds if not managed correctly.

For those who are going to add money to their holdings along they way, no-load funds that are bought directly from the fund family can save money on commissions if the fund fees are not far more expensive than an ETF. Most Vanguard and Fidelity index funds are as cheap as ETFs (and in many cases cheaper) and offer a cost advantage when considering the commission and bid/ask spread to buy and sell ETFs.

The trouble of course is figuring out which actively managed fund will beat a benchmark index going forward - a task bordering on impossible. On the other hand, what are your chances of beating a benchmark index buying and selling ETFs like a mad hatter?

We prefer a mix of lower fee actively manged open-end funds and index funds to an all-ETF portfolio. Depending on how you are using them, the index funds can be open-end or ETFs. We also think more harm than good will ultimately be caused by most of the new fangled ETFs being launched nowadays.


Fund-O-Matic Fund Screener

May 16, 2008

We're pleased to announce the beta launch of our new Fund-O-Matic Mutual Fund Screener - the easiest way on the net to find great mutual funds.

Click on the orange boxes on the left hand side to expand your fund search options - then click, un-click and combine those options to view your customized fund list in the table on the right.

Please note that this is a beta release, so there might be a bug or two. If you come across anything that's not quite working right, or if you have any questions about our new mutual fund screener, let us know by clicking here.

Fundo-O-Matic Fund Screener

May 16, 2008

We're pleased to announce the beta launch of our new Fund-O-Matic Mutual Fund Screener - the easiest way on the net to find great mutual funds.

Click on the orange boxes on the left hand side to expand your fund search options - then click, un-click and combine those options to view your customized fund list in the table on the right.

Please note that this is a beta release, so there might be a bug or two. If you come across anything that's not quite working right, or if you have any questions about our new mutual fund screener, let us know by clicking here.

Another Prediction For The Death Of Funds

May 8, 2008

The Wall Street Journal (yet again) discusses the probability of the slow end to the twelve trillion dollar mutual fund industry:

Mutual funds have been resilient despite rivalry from other investment options like exchange-traded funds, hedge funds and separately managed accounts, but now some investors are having their doubts.

A recent survey by consultants Cogent Research in Cambridge, Mass., suggests that many affluent investors have great concerns about the fund business. Among other things, the survey found that shareholders believe fund companies don't have their best interests at heart, citing such issues as excessive trading, lack of transparency in fees and a failure by the industry to clearly articulate tax and risk issues. The survey was commissioned by Barclays Global Investors, a giant in exchange-traded funds, or ETFs, and a unit of Barclays PLC."

We blogged about this study a few days ago (29% of People Trust the Fund Industry...), and still don't think it signals a death knell for mutual funds. Funds still offer key benefits, especially for the legions of 401(k) investors:

1) Low Minimums - investors can efficiency get active or passive management into just about any market in the world with as little as $1,000.

2) Cheap to Buy and Sell - investors can add a few bucks a week without paying commissions (which they can't do with stocks or ETFs).

3) Built In Sales Loads - O.K. this isn't really a benefit to buyers so much as sellers, but so long as funds can obfuscate such commissions, ETFs will never take over the world. There is no way to manage a client account easier and more profitably (to the broker) with more fee obscuring than with load-bearing mutual funds.

4) Fund Performance - everybody whines about how crummy fund performance is, but if you could easily compare fund performance to individual accounts at say E*Trade or even many broker managed accounts in stocks, the fund industry wouldn't look to shabby.

Other criticisms of funds noted in this article barely hold water. One source notes that funds get paid to gather assets, not perform well - and people are wising up to this fact. While nobody complains about the evils of giant funds more than we do, the reality is funds don't get big or stay big without decent performance. And what's the alternative? Performance based fees, like those most hedge funds levy, have their own drawbacks: a 20% cut of profits can be an incentive for hedge fund managers to take big risks with investors' money.


Gold Funds Attract Gobs Of Money, Promptly Fall

May 6, 2008

Fund investors have a knack for bad timing. TheStreet.com notes "Money Pours Into Precious Metals Funds":

Investors continued to pour into precious metals in March, adding a hefty $1.2 billion into the mutual funds and exchange-traded funds that concentrate on the specialty sector.

That brought the total flow of cash into the subsector for the first quarter to $3.6 billion as investors sought safe-haven assets amid the ongoing credit crisis."

Recently gold was about where it was when it started the year, but this doesn't mean investors are flat for '08. According to Lipper, these flows into gold funds were skewed to March. Gold ran up into quadrupole digits from January through early March only to fall back sharply. If much of the money went in during March, this money is at a loss for the year.

As a group over the last few years fund investors have made money in precious metals funds. Most funds in this category have sizable net unrealized gains on the books. But gold funds were unpopular years ago, and have grown in popularity as the shinny metal rose in price (and the positive coverage rose as well). It won't take a fall to the old prices to wipe out all the gains made in gold funds - even a dip to $500 per ounce could do the job given how much money has piled in during the last two years.

The volatility and hot money flows are some of the reasons why we have a hard time stomaching gold's increasingly popular "safe-haven" moniker. Anything that can fall 15% in a few weeks shouldn't qualify.


Market Up, Fund Investors Back in

May 1, 2008

Fund investors tend to sell low and buy high. They like the thrill of the chase. When the market is falling hard, they want out. When it is rising fast, they want back in. If they sold before the market fell more, or bought before it went substantially higher, this would be a brilliant strategy. Unfortunately, as several studies of long term mutual fund investor returns show, fund investors underperform by chasing the market's tail.

As we noted in mid-March when the Dow was dipping below 12,000 (mere days before the market turned back up), fund investors piled into money market funds. Now with the Dow on the verge of 13,000, the money seems to be coming back:'

Investors to money-market funds subtracted $34.53 billion in the week ended Tuesday, bringing total net assets to $3.416 trillion, according to the Money Fund Report."

Is this a flawless contrarian timing strategy? No. However, if you are not a buy-and-holder, you'd probably do better buying when fund investors are bailing, and cutting back when they are diving in.


29% of People Trust the Fund Industry

April 28, 2008

Bill Donoghue at Marketwatch reports on a survey of high-net worth investors which reveals that the vast majority think the fund industry is less trustworthy than (gasp!) auto mechanics!

About 71% of investors don't trust the fund industry.

Meanwhile, 66% say fund firms don't take responsibility to protect investors' financial well-being.

In fact, mutual funds are at the bottom of the list of trusted service providers -- below mechanics and insurance agents.

Investors' major source of distrust is the disclosure of fees, risks and tax implications. These caveats are spelled out in excruciating detail in funds' unreadable prospectuses (which are supplied to everyone except retirement savings plan participants)"

As Donoghue points out, the survery was commissioned by Barclays whose exchange traded fund products are mutual fund competetors, so the results should be taken with a grain or salt or two - but frankly investors' distrust of the mutual fund industry is well founded. Mutual fund companies exist to make money, and most are less interested in investors' 'financial well-being' than thier own. If they weren't, all funds would be no-load and have a .5% expense ratio. The good news is that there are some fund companies that have realized that the best way for them to succeed is to provide high-quality and low-cost and no-load funds to investors. Just like there are honest mechanics and those that will tell you you need a new engine when all you need is a tune up, there are good fund companies and those that will launch internet funds at NASDAQ 5000.