ETFs are not created equal

By Felix Salmon
August 26, 2010
Paul Amery grabs this chart from a recent Deutsche Bank report:

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Paul Amery grabs this chart from a recent Deutsche Bank report:


The different lines are various ETFs, all of which seek to replicate the Euro Stoxx 50, which is the black line in the chart. Nearly all of them managed to outperform the index over the 20-month period in question, although if I were an investor in UBS’s ETF I’d certainly be asking questions. And it’s pretty clear that the degree of outperformance in many cases is a much larger component of total returns than is the headline expense ratio on the funds.

The chart shows post-fee performance, but it’s clear at a glance that it’s not lower fees which account for outperformance. Instead, explains Amery, a lot of it is dividend-tax jurisdiction shopping: funds will domicile themselves in countries with low dividend taxes, and/or lend out stocks over the dividend date to other funds in low-tax countries. For a fund like the Euro Stoxx 50 which comprises stocks from many different countries, the effects can be substantial.

None of which helps, particularly, in working out which fund to buy going forwards. Amery concludes:

It’s difficult to ascertain how the increased performance is actually being generated, why certain funds are doing better than others and what risks might be being incurred by the funds’ investors. In order to answer these questions in greater detail, investors would need to look more closely at securities lending activities, collateral policies and (for swap-based funds) the terms and conditions of the contracts between their ETF and the swap counterparty or counterparties. However, ETF managers’ disclosure of information in these areas is typically very limited indeed.

So, if you owned the iShares Euro Stoxx ETF, congratulations. If you owned the UBS version, commiserations. Going forwards, one can try to guess that iShares will continue to outperform. But that’s all it would be — a guess. We have no good reason to know why that might be the case.


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Historically, Gus Sauter was able to do the same at Vanguard. Their low expenses helped but good execution and use of options was the key.

Posted by ErnieD | Report as abusive

Domicile (ongoing withholding rates) and size of securities lending revenue (dividend arbitrage) are key. You need to examine either:
a) the swap contract with the fund if swap based – the proportion of “revenue enhancement” that will be shared with the fund – which may be a higher rate when the AUM is small (to juice performance) and lower when the AUM is large (to keep more revenues for the i-bank)
b) how large the physical ETF asset manager is in the lending markets – BGI is huge, everyone else is small (relatively)
For the Euro STOXX 50 index you may notice a bulk of the outperformance occurring in Q2 when dividend season occurs in the Continent and the effect of withholding rate mitigation is highest.

Posted by MilesDavis | Report as abusive

The only excuse I can come up with for the UBS poor performance (apart from a history of poor performance across their fund range generally and various scandals involving CHF 60 billion losses from sub-prime, CHF 900 million a few years back from options trading, and various other incidents) is that the UBS ETFs are index trackers… that would explain why they sat on the index pretty closely. If they aren’t trackers, what on earth are they doing?

Posted by FifthDecade | Report as abusive

Thanks Felix for the link and your comments.

Miles, in my article (linked in Felix’s first line) I do comment on the timing of the ETF outperformance vs. the index – which corresponds for some (but not all) of the funds to the April/May European dividend season, as you point out. Your comments about how revenue enhancement may be at a higher rate when a fund is small (to get it going and entice investors) and on the impact of size in the securities lending market are interesting,thanks. This surely reinforces how much discretion ETF and index fund managers have and how this industry is a lot less “passive” than it seems at first glance.

Paul Amery, editor,

Posted by Pamery | Report as abusive

Good takeaway Paul – index fund management is not passive. There are horses for courses, and each manager has their pros and cons.
[disclaimer - i am a former industry veteran who has no axe to grind here - just alot of experience with ETFs]

Posted by MilesDavis | Report as abusive