If you are going to build a house, use quality materials. Then it will last for a long time. The same philosophy applies to portfolio construction: use quality index ETFs (exchange traded funds). How can you pick the sturdiest oak, steel, and glass from the detritus of 1000+ ETFs available today? At Osbon Capital, we start with four tests, which quickly separate what we consider the best from the rest.
Representation – Simply put, an ETF should duplicate the index on which it is based as closely as possible. A great example is DIA, the SPDR Dow Jones Industrial Average. DIA replicates the 30 stocks in the Dow Jones Industrial Average, with as close as practicable their exact weights. Thus, the performance of DIA is virtually identical to that of the DJIA. In industry parlance, that means there is no appreciable “tracking error.” What you see is what you get.
Tax Efficiency – A huge advantage of a properly constructed ETF is its tax efficiency, the ablility to compound over a long period of time without paying any capital gains taxes. SPY, the SPDR S&P 500, is the poster child for industry. It is one of the largest and also the oldest ETF, and has not had a capital gains distribution in 19 years of existence and 200% appreciation.
Cost – Don’t pay more than you have to for anything. Vanguard is leading the race to the bottom in ETF expense ratios (costs) and to the top in asset management size (Vanguard is now the largest fund manager with over $2 trillion under management, most in indexes.) VTI, Vanguard Total Stock Market ETF, has $183B in assets and an expense ratio of 5/100 of one percent, so small you can hardly see it. Low cost means you keep more of your money.
Sponsorship – As the ETF industry matures, the creators and operators become more important. The big are getting bigger, and investors and instituitions are voting their dollars into what they consider the “best” ETFs. BlackRock, State Street, and Vanguard dominate the ETF industry in number and size of funds. While there may be room for the occasional other sponsor, I look extra carefully before using an ETF outside the sponsorship of the Big Three.
While the best ETFs are characterized by the transparency, low cost and tax efficiency that make them so desirable as investment construction material, eternal investment vigilance is necessary. At Osbon Capital we stay current on developments as avid consumers of index information provided by the industry and by independent outsiders and analysts.
Below are the commodity ETFs we currently utilize. Click here for the complete list.
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ETF data from Bloomberg and Yahoo Finance, for week ending June 22, 2012. ETFs listed are those most often used in client portfolios. Some portfolios may contain other securities. Osbon Capital, a fee only investment advisor, receives no compensation from any fund providers.
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