ETFs are not created equal

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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