The ETF Select List Is Here ! And It Stinks!

Schwab published an ETF Select List of what it describes as the best fund choices for 50 categories. While there is a little utility, for the most part it is worthless.

The list seems to be targeted at an Investing 101 or maybe Investing 102 audience. Most of the equity categories are broad and so in choosing the best funds for each broad category many of the funds are from Schwab and bunch more from Vanguard. I'm not critical of the fact that so many Schwab funds are the best pick. I heard an interview on CNBC about this earlier in the week and one purpose here is best choices for Schwab customers. The expense ratios of Schwab's funds are very competitive and there is no commission to trade them at Schwab. In that light where each ETF provider has, for example, a total market funds and the correlation between all of them will be 99 or 100 then why not go with cheapest possible choice?

While the above is true it would seem to rule out things like RAFI, WisdomTree, Revenue Shares and probably a couple of other providers who may have built better mousetraps.

The sector sections is truly pitiful. Nine of the ten sectors are the Select Sector SPDRs, the only one that isn't is telecom because there isn't a true Sector SPDR for telecom (the SPDR Telecom ETF is brand new, seems to own names not in the SPX and is not cap weighted). For Telecom they have iShares US Telecom (IYZ). Somehow, the methodology ignores a lot of fund families where sectors are concerned.

What about PowerShares? The PowerShares Dynamic Energy Sector ETF (PXI) has outperformed XLE since inception, for one year, for two years and for three years. PXI has an expense ration of 0.65% versus 0.20% for XLE. So yes XLE is cheaper and while making a decision based solely on past results is not a great idea, PowerShares probably does deserve a seat at the table.

The other thing that is lost here with sector funds is foreign sectors which appear to get no consideration as a category (meaning they might as well not exist) not to mention niche funds that can serve as proxies for sectors. Domestic sector funds can look very different from foreign sectors funds and this becomes very important in portfolio construction.

The easiest example here is probably the materials sector. What has been the allure of the sector over the last five years or so? I think one big driver has been mining stocks. The Materials Sector SPDR (XLB) is more about chemical stocks than mining companies. Dupont (DD) and Dow Chemical (DOW) add up to 22% of the fund and there are many other chemical names in the fund. Freeport Mcmoran (FCX) and Newmont (NEM) combine for 20% of the fund, but they appear to be the extent of the mining exposure. There are also a lot of metals producers and depending on the particulars these could be price takers not price makers which would matter to me.

A fund like iShares Global Materials (MXI) on the other hand has 56% in mining and it is the miners that dominate the top ten. Some clients own MXI. As another example the EG Shares Emerging Metals and Mining ETF (EMT) appears to have about 70% in mining companies (if you include coal companies). Relative to being the same sector I think the differences in performance are enough to matter but this could be in the eye of the beholder.

The country fund section only had two countries; Japan and China. Long time readers will know the importance I place on country selection and by only having two countries Schwab is simply ignoring this segment.

The exchange traded product space has vast possibilities for portfolio construction (preferably in conjunction with other products) but the select list doesn't begin to take take advantage of what is out there.