Going Down The ETF AUM Ladder Can Mean Higher Returns

Published December 03, 2012

| Benzinga

One of this year's more prominent themes in the exchange-traded products industry has been a record number of closures. Ninety-nine to this point in the year, the Wall Street Journal reported, citing Lipper data. As the Journal notes, that is more ETF and ETN closures than in the previous three years combined.

An increased rate of ETF closures is a sign of an evolving, maturing industry. That much is known, but the naysayers do not stop there.

Rather, they continue to wage their war of opinion-based criticism on small ETFs, fingering those funds with less than $100 million in assets under management as the next legitimate candidates for closure. As has been previously noted, this talk is not cheap. Actually, it is quite costly because all the fear mongering keeps investors out of many small ETFs with big-time returns.

Investors can only imagine what the critics would have to say about ETFs with less than $50 million in assets under management if those same critics are so ready to assail funds with less than $100 million in AUM. Usually, the arguments revolve around perceived lack of liquidity and wide bid/ask spreads. The latter issue is seen as driving up investors' costs, which is true. However, is the investor that paid a 15-cent spread to buy an ETF that is up 30 percent this year not doing better than the investor that paid a penny spread to get an ETF that has gained just five percent?

Perhaps the small-ETF critics should consider the returns offered by this collection of sub-$50 million funds.

EGShares India Consumer ETF (INCO) Finding coverage of INCO is like looking for a needle in a haystack and that is understandable when considering the fund has less than $2.4 million in AUM, according to ETFdb data. However, INCO's lack of coverage should not be condoned.

After all, Indian consumer spending is projected to surge in the coming years and INCO offers a direct play on that same. Maybe the ETF is already starting to price that theme in. Despite its diminutive AUM total, INCO is up more than 50 percent year-to-date. Said another way,, an investor would have to add up the returns of two of the most popular India ETFs to arrive at a number that exceeds INCO's returns.

First Trust China AlphaDEX Fund (FCA) With the one fund controlling the bulk of the assets and volume when it comes to China ETFs, it is easy for rival funds to get lost in the shuffle. The problem is that scores of other ETFs outperform the largest China fund, underscoring the notion that bigger is rarely better when it comes to ETFs.

That is certainly the case with the First Trust China AlphaDEX Fund. The fund has just $2.2 million in AUM. Critics would say FCA is a possible candidate for closure. An unlikely scenario given that First Trust has never shuttered an ETF.

So what have investors sacrificed by passing over FCA for the comfort and tighter bid/ask spreads of the unnamed China ETF giant? Nearly 1,400 basis points of alpha this year.

Market Vectors Emerging Markets High Yield Bond ETF (HYEM) As the mainstream financial press has been so eager to cover outflows from the most popular high-yield bond ETFs, ignored has been the story of the newly minted Market Vectors Emerging Markets High Yield Bond ETF.

HYEM debuted in May, so it is not old enough to draw the ire of the ETF closure crowd. It is, however, young enough for the "investors must let new ETFs age in an oak barrel like a fine whiskey before buying" crowd. Plus, those critics would say HYEM only has $21.1 million in AUM, so it better start attracting inflows soon or else.

Well, performance and yield-hunting are factors that bode well for HYEM's future. The fund has returned nearly 6.2 percent since its debut. By adding up the returns of the two largest U.S.-focused junk bond ETFs over the same time period, investors would still be left with a performance number that trails HYEM by nearly 70 basis points. Oh yes, HYEM yields 6.63 percent and pays a monthly dividend.

For more on ETFs, click here.

(c) 2012 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.

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