I’m not sure if I’ve ever told you guys about my favorite ETF, but I guess there’s no time like the present, huh?
There’s later. That’s a time.
You don’t show up for months and that’s what you give us? Thanks for nothing, Italics Man.
There are some really dumb ETFs out there. I’ve profiled at least one over the years, which was just a high-interest savings account that paid out a very small monthly distribution. I also looked at a stock buyback ETF that did a pretty poor job of actually picking stocks that repurchase shares.
But my absolute favorite sector ETF is the BMO Equal Weights Bank ETF (TSX:ZEB), which charges you (yes, you specifically) a 0.62% management fee to hold equal positions in six different bank stocks (the big five everyone has heard of and National Bank). That’s it. That’s the whole ETF. What a scam.
Reminder: your ETF fees really add up over time.
The Equal Weights Bank ETF is the worst example of the problem, but there are sector ETFs out there that are barely better. Investors buy them for instant diversification without realizing they’re dominated by a handful of names. And the management fees are damn high, especially for what you get.
Let’s take a look at a few of the worst offenders.
The worst sector ETFs
You’d think it would be the financial sector, but not really. It turns out there are a lot of insurance companies and whatnot that get decent exposure.
Let’s start with the largest utility ETF, the iShares S&P TSX Capped Utilities Index (TSX:XUT). It has 16 different holdings and will set you back 0.61% each year. Get used to that number; you’re going to see it a lot.
The top five weightings are 65% of the fund, and the top three are 50% of the ETF. That seems like a little much to me, but maybe that’s just my active investor bias talking.
The iShares S&P TSX Capped Consumer Staples ETF (TSX:XST) has a management fee of 0.61% and has a grand total of ten different holdings. This is what you’re paying more than half a percent a year for. It’s the entire ETF.
Almost 81% of this ETF’s holdings are concentrated in the top five names. It could easily be more diversified, too. It doesn’t own High Liner Foods, Rogers Sugar, Molson Coors, Andrew Peller, or even Dollarama. Why? Damned if I know. But hey, way to buy both Loblaw and George Weston. The latter owns about half of Loblaw.
Before I feature the worst sector ETF of all, I do want to point out these aren’t big funds. Both the utilities and consumer staples ETFs are only flirting with $100 million in total assets. That makes them nothing burgers in the big world of finance. This next pick is bigger but with assets of $163 million it’s not exactly a powerhouse.
That’s right, kids. A full 88.4% of this ETF’s assets are stuffed into the top five holdings. This is something you could very easily replicate on your own and avoid the hideous fee.
When are sector ETFs useful?
Not every sector ETF sucks. There are a few decent ones.
The REIT one (TSX:XRE) isn’t bad. It has 16 holdings without huge exposure to the top five companies. I’d still rather pick individual REITs and the TSX universe has about 50 different REITs to choose from, meaning it’s really not that diverse. It’s still a decent place to start for investors looking for a little real estate exposure.
The iShares Preferred Share ETF (TSX:CPD) is also a pretty solid choice for folks looking for a little income that isn’t really correlated to the overall stock market. Again, I’d rather pick individual preferred shares but it’s a decent hands-off option.
I also think there’s potential to use sector ETFs to bet on either the energy or material sectors recovering. I wouldn’t even touch those sectors with your Visa card but there are certainly worse ways to bet on a sector coming back into favor.
Let’s wrap it up, pup
I realize sector ETFs are specialty products that not many people own. That’s good. We don’t want large groups of investors to acquire these things.
I’d recommend somebody looking to overweight a sector to just pick the best names in that particular part of the market and build your own mini sector ETF. Most of the big ones in Canada concentrate on a few top holdings meaning it’s really easy for you to replicate one on your own.