After 12 weeks of entries, I’ve decided to adopt the advice of people more experienced than me in the blogosphere, and write a more detailed single-topic entry. This article suggests a list of 7 ETFs retail investors need post-pandemic, based on the thoughts I had written about in previous posts. These are instruments that are most appropriate for US-investors. For non-US investors, tax implications would in most cases make investing in these uneconomical. I am planning to write a separate post on vehicles for non-US investors in the coming weeks. Please watch this space.
For readers new to investments, ETFs (Exchange-traded funds) are collective investment vehicles. They allow investors to invest a small amount of money across a large number of companies’ securities. This gives investors the benefit of diversification at a very low cost. There are also typically liquidity requirements for inclusion of a company’s securities in an ETF. This mitigates the risk that an investor might need to take a fire-sale price for her investments when she needs to sell in times of stress.
The seven ETFs are:
- SPDR S&P 500 ETF Trust
- Invesco QQQ Trust
- Vanguard Russell 1000 Value ETF
- Vanguard Russell 1000 Growth ETF
- SPDR S&P Biotech ETF
- iShares Core S&P Small-Cap ETF
- iShares Gold Trust
1. SPY – SPDR S&P 500 ETF Trust
This is the grandfather of US ETFs. It listed in 1993 and currently has AUM of about US$275 billion. As the name suggests, the ETF attempts to replicate the performance of the S&P500 Index, which component securities are chosen to represent the US large-cap space. Currently, the asset allocation is about 27% in information technology, just under 15% in healthcare, just under 11% in consumer discretionary and communications respectively, and just under 10% in financials.
In his 2013 letter to shareholders, Warren Buffett famously explained concerning his will:
What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit. … My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund.
Warren Buffett, 2013 Shareholder Letter, Berkshire Hathaway
He recommended Vanguard’s fund though, which has an expense ratio of 14 basis points. In contrast, SPY has an expense ratio of 9.5 basis points or 0.095%, which is very reasonable for an equity fund offering broad exposure to all sectors in the US economy.
2. QQQ – Invesco QQQ Trust
If SPY is the grandfather of large-caps ETF, QQQ would be the grandfather of large-cap growth stocks. The “triple-Qs” or “cubes” began life in the go-go dot-com era in 1999, tracking the NASDAQ 100 Index. In particular, it focuses on technology (63%), consumer discretionary (21%), and healthcare (just under 8%) sectors. It excludes financial stocks, which is an attractive feature for investors wary about the implications of zero-rates environment on financial companies.
It has an AUM of US$115 billion and an expense ratio of 20 basis points. The nearest competitor is First Trust NASDAQ-100 Equal Weighted Index Fund (QQEW), which has an AUM of US$866 million and an expense ratio of 59 basis points.
A note of caution is in place here. QQQ’s popularity gave rise to leveraged ETFs that give day-traders the potential to make returns that are a multiple of the returns of QQQ. These leveraged instruments include one known as TQQQ – ProShares UltraPro QQQ. This provides day-traders the potential of up to triple (hence the “T” in TQQQ) the returns of QQQ, and of course the losses as well.
3. VONV – Vanguard Russell 1000 Value ETF
I mentioned this in a previous post, using it as a proxy for Value investing. The fund tracks the Russell 1000 Index, which covers a wider range of companies with a lower market capitalization that the S&P500 Index does not cover. More pertinently, the index has a 27% weight allocation to financials. This is followed by healthcare at just under 15%, utilities at just over 12% and consumer discretionary at just under 11%. Allocation to technology is a low 7%.
The fund, which started in 2010, has an AUM of US$3.6 billion, which is about a tenth of an older competitor IWD, iShares Russell 1000 Value ETF (started in 2000), with AUM of US$34 billion. Given the name of both ETFs, it should not surprise readers that their largest holding at 2020 May 31st was Warren Buffett’s Berkshire Hathaway Inc.
The attraction of VONV is its fees – at just 8 basis points compared to IWD’s 19 basis points. It is even lower than that of SPY. However, the trade-off is the bid-ask spread, which is 5 basis points for VONV compared with IWD’s 2 basis points.
In no small part due to its low allocation to Technology and other high growth sectors for the past decade, the performance of VONV has lagged that of its growth-style sister fund VONG during the same period.
4. VONG – Vanguard Russell 1000 Growth ETF
Like its sister fund VONV, VONG also started in the year 2010. While also tracking the same Russell 1000 Index, the style focus means that VONG’s sector allocation is significantly different to that of VONV. The largest sector exposure is Technology at 41%, followed by consumer discretionary at 18.6%, healthcare at 14.5% and financials at just under 12%.
For QQQ investors, the largest holdings of VONG would look familiar: the top 5 lists Microsoft, Apple, Amazon, Alphabet and Facebook. A key difference between QQQ and VONG is their exposures to financials – QQQ has zero exposure.
Just as sister fund VONV competes with IWD, VONG competes with another sister fund of IWD, known as IWF: iShares Russell 1000 Growth ETF. The younger fund VONG has an AUM of US$7 billion, compared with US$54.8 billion at IWF (started in 2000). Again, the VONG attraction is in the level of fees – 8 basis points, compared with 19 basis points for IWF. The bid-ask trade-off is slightly better than that for the value fund: 4 basis points for VONG and 2 basis points for IWF.
While outperforming VONV and SPY, the allocation to financials also means that VONG lags QQQ’s performance for the past decade.
5. XBI – SPDR S&P Biotech ETF
I mentioned this in a previous post, comparing it favorably against VONG, SPY and VONV. Even before the pandemic, biotech, and the life sciences were already capturing investors’ imagination and investments. Now, this is arguably the most critical fund amongst the 7 ETFs Retail investors need post-pandemic, as the race for bio-security would likely lead to even more focus and attention to this sector.
iShares and State Street were early to this sector, entering the market in 2001 and 2006 respectively. iShares’ IBB, with AUM of US$9.5 billion, overweights the top 10 names by market cap. State Street’s XBI (AUM US$5.4 billion), on the other hand, adopts an equal weight approach, thus overweighting the mid- and small-cap names. I think that the latter approach fits the current developmental phase of the biotech industry better.
It also helps that XBI has a lower expense ratio at 35 basis points than IBB’s 47 basis points.
6. IJR – iShares Core S&P Small-Cap ETF
Previously, I wrote about an Oxford University study about PE funds and billionaires. The study shows that in the market for mid- and small-cap investments via private equity funds, PE funds founders are the biggest winners. The study also shows how retail investors can generate returns similar to that of PE Funds’ limited partners by investing in small caps mutual funds. One of the funds mentioned, T Rowe Price’s Small Cap Stock Fund, turned out to have been closed to new investors since 2013. Hence I look for ETF alternatives that might do the job.
Since 2000, iShares’ IJR has been tracking the S&P SmallCap 600 Index. While replicating the benchmark performance, it trades off benchmark diversification in return for better liquidity. It has an AUM of US$39 billion and an expense ratio of 6 bps.
The historical return since inception looks low at about 7.6% p.a.compared to the 10%+ for PE funds’ LPs in the Oxford study. I half-suspect this is due to the recent market crash for small-caps, which has not recovered compared with large-cap and growth stocks. For an extended period from 2012 to 2018, IJR outperformed VONG.
7. IAU – iShares Gold Trust
Given the amount of quantitative easing sloshing around the world after the GFC, Brexit and now the pandemic, it is not inconceivable that the value of fiat currencies would be gradually depreciated over time. I wrote about this in a post on Exter’s inverted pyramid previously. The price of gold has also risen from US$1,520 per ounce in the beginning of the year to almost US$1,785, an increase of 17% in 6 months. In view of this, this fund deserves a place amongst the 7 ETFs retail investors need post-pandemic.
iShares came to the market with IAU in 2005. It currently has AUM of US$26 billion, and an expense ratio of 25 basis points. Its larger peer, GLD SPDR Gold Trust, has an expense ratio of 40 basis points despite being larger (AUM US$67 billion).
The problem for US investors relates to capital gains tax on gold, which is treated as a collectable by the IRS.
Performance
Tracking from 2010, the most recent inception date of the ETFs mentioned above, the performance of the 7 ETFs are as follows.
XBI, the biotech fund, has been leading all the way in the past decade. This is followed by QQQ, with VONG a distant third. While the small-cap IJR was ahead of VONG for a good part of the past decade, the recent pandemic has exacerbated its fall since 2018. VONV has consistently lagged SPY. Gold has been the worst-performing asset for the last decade, though it has been catching up with VNOV in recent months.
Conclusion
For US investors looking to invest for retirement, or simply to preserve and grow the value of their wealth, ETFs are low-cost vehicles. The 7 ETFs retail investors need post-pandemic above offer good coverage of sector exposures across the US economy and even an inflation hedge. They are a good starting point in a retail investor’s journey post-pandemic.
