Possible ETFs for an IRA

This is a commentary on a recent (4/15/2011) post on ETFdb.com, which suggest "Five ETF Picks for Your IRA". The five picks (BICK, DBC, HYLD, KBWD, and TAN) are suggest to be "interesting long term picks for any portfolio". The same article also appears on SeekingAlpha.com.  Let's look at these ETFs one at a time.

BICK

This fund is a take off on the BRIC (Brazil, Russia, India and China) them. Instead of Russia, the fund has stocks from South Korea. According to ETFdb, this fund tracks the ISE BICK INDEX and "The index is designed to track the largest and most liquid public companies that are domiciled in Brazil, India, Mainland China and South Korea. "  The holdings are about evenly split among these 4 countries, and the largest category of holdings is financials at ~27%, and energy is <9% of the funds holdings. For comparison, the largest BRIC fund, BKF, has almost 25% in energy and about 22% in financials; in addition, the country split is not as even with a range from ~36% in China and ~14% in India.Clearly, BICK is a different kind of BRIC! How does swapping South Korea for Russia and the concomitant reduction in energy exposure affect performance? Use a perfchart at stockcharts.com to show a comparison of BICK and BRF; move the slider at the bottom all the way to the left. Today's comparison shows that BICK is up abut 12% and BRK is up only about 7%. The volatility (ups and downs) looks similar, importantly, at least to me, BICK has been a few percent points above BRF for most of the past year. Avoiding Russia with its oil dependence and uncertain politics might be a good idea. One caution about BICK is that it has very low volume (only 6,245 shares on 4/15/2011 compared with 245,198 for BKF- data from finance.yahoo.com). If you buy a low volume ETF be sure to place a limit order near the bid price so that you don't get trapped by a big spread between bid and ask.

DBC

DBC is a commodities ETF that holds "futures contracts on 14 of the most heavily-traded and important physical commodities in the world" and tracks an index developed by Deutsche Bank. A look at a perfchart of DBC shows a gain of ~27% for the past year (250 days) and a gain of only ~37% total for the past >5 years (1311 days). This is clearly not a buy-and-hold fund. It would seem to be a buy when inflation is on its way up and, thus, commodities are going up. A possible alternative to DBC is USCI which track and index that is "comprised of 14 Futures Contracts that will be selected on a monthly basis from a list of 27 possible Futures Contracts. The Index is rules-based and rebalanced monthly based on observable price signals." A comparison perfchart of DBC and USCI shows that since its inception in August 2010, USCI has significantly outperformd DBC with a gain of 42% for USCI and 33% for DBC. The graph spans 175 days, just short of 9 months, and the advantage of USCI over DBC widens over the time. If you want a commodities ETF, USCI looks like the better bet.

HYLD

HYLD is a an actively managed high yield bond fund which does not track an index. The fund has 40-60 holdings at a time picked by the advisors and can include treasuries if the advisors feel so inclined. The big competitors in this area are JNK and HYG. A perfchart comparison of HYLD, JNK, and HYG for the past 91 days, i.e., since the time of the creation of HYLD, show almost no difference and perhaps a slight advantage for HYLD. Note that it is important to use the perfchart of the comparison of ETFs (or stocks) with high dividends because this type of chart shows the results with dividends reinvested. It would seem that HYLD is worth watching over a longer period of time.
                           
KBWD


KBWD is a high yield financial sector ETF which is yield weighted rather than cap weighted. The big player in the financial sector is XLF. A perfchart comparison of KBWD and XLF shows XLF with a 10% gain and KBWD only a 5% gain over the 95 days since KBWD debuted in December of 2010. Maybe time will reverse this, but, for now, I'd give KBWD a pass.


TAN


TAN is an alternative energy ETF. More specifically, it is a solar energy ETF. ETFdb lists 14 alternative energy ETFs. The only other one that is a solar sector play is KWT which matches TAN's performance in a perfchart for over 3 years -- both with a loss of -70% stemming from the big crash of 2008.  There has been virtually no net change in the past 1-2 years and big 10-20% swings with no clear trend. The recent earthquake/tsunami/nuclear disaster in Japan resulted in a big spike that persists. This one and this sector might have some very long term promise, but it would seem that a short-term timing strategy would be more appropriate. Timing is hard to do!


Conclusions:


I would go for BICK and USCI. HYLD is worth watching.

Building an ETF Portfolio

An ETF consists of a collection of stocks or other securities that usually track an index (see What is an ETF?). Thus, each ETF is approximately as diversified as the index that it tracks. Since each index represents some defined sector of the investment world, constructing a portfolio requires that you decide what parts of the market you want to invest in. Making these choices can be easy or hard depending on your investment goals.

If your goal is to purchase a large cross section of the US stock market, there are 4 ETFs (VTI, IWV, TMW, and SCHB) that each track an index that represents most of the US stock market. Each index is slightly different so the performance of these ETFs is slightly different from each other. If you click here, you can see a "perfchart" graph from stockcharts.com that shows the performance of VTI, IWV and TMW, all of which have been in existence for over 10 years. The perfchart (short for "performance chart") shows the total performance of each ETF, i.e., reinvestment of the dividends and other distributions is assumed on the day following the distribution pay date. The default view is for 200 market days, i.e., 40 weeks. A slider in the bottom right hand corner of the graph lets you view an arbitrary period back to the time of the most recently created ETF. SCHB is a more recently created ETF, so when you click on this sentence you will see a graph comparing all 4 of these ETFs. Again move the slicer to see the entire history back to the creation of SCHB.

Which of these 4 ETFs should you buy? One way to choose is which one is cheaper to own. What does this mean? Not surprisingly, each ETF charges an annual fee to take care of your money. The annual fee is "magically" included in the price of the fund and the distributions it give, so it is essentially transparent to the owner. The size of the annual fee, however, will affect the long-term performance. If you consider the fees alone, the SCHB ETF has the lowest charges, and if you buy it through an account at Schwab, there is no commission fee to either buy or sell the ETF. If you are an ordinary investor, no commissions can be a big saving. For example, the standard commission at Schwab is 8.95. If you buy a $1,000 worth of shares, you pay an additional $8.85 which is 0.89% of the total. For a buy and sell, this amounts to 1.78%. This adds up over time. The impact is, of course, much worse if you make big purchases and sales, but if the commission is zero the savings are clear. Other brokers also have no commission ETF's so shop around.