The following figure shows the trading premiums of the two types of ETFs.

Clearly allowing cash creations helped to reduce the trading premiums.

It sure looks like there is yet another factor to consider when purchasing ETFs, especially if the underlying assets are illiquid.

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• Low expenses : the lower the expense ratio, the better.
• Diversification : for investment grade bond funds, generally the more holdings, the better.
• Amount of assets & trading volume : generally the larger the better (improves liquidity, smaller trading spreads).
• Duration : duration is a measure of the sensitivity of the fund price to interest rate changes. At this juncture in the economy, I would prefer not to go too long on duration.
• Credit quality : no junk bond fund for me.

The ETFs that I narrowed down to include BSV, CSJ, AGG, BIV, CIU and LQD. These are listed in the table below:

From the look of it, I would probably go with CSJ,  the iShares Barclays 1-3 year credit bond ETF.

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Is there a recommended method of doing a TLH? I tend to like to TLH on market downturns if at all possible. Currently I start with the ETF that I would like to sell. I look at the bid/ask, and I generally choose the higher “ask” price to set as my limit order. Even though I’ve chosen a down day to sell this ETF, obviously I would like to get on the higher side of the bid/ask spread since I am selling. The moment the sale goes through I start working on buying the replacement ETF. At this point I do not like to miss the opportunity to complete the sale due to greed. I put my limit order at exactly the lower “bid” (not the higher ask) price. I observe it closely for a few minutes to half an hour to see what it’s doing. If it looks like it’s veering upwards I will raise my limit to the current bid price. If after a while it looks like I’m going to miss the boat, I simply raise my limit order to the ask price instead of the bid. Generally this will execute the order. Most of the time I execute both orders within a few minutes to half an hour without being hosed too serverely.

I thought it would be interesting to hear what people have to say. Anyway, the following is what I do:

I enter the two orders first, but with out-of-range prices using limit orders. I open two windows — one for the purchase, one for the sale.

At the point when I want to execute the TLH, I modify one of the existing order to the price which would complete the transaction. As soon as I verify that the order is completed, I modify the price of the second order (modifying an order’s price is much faster than entering the complete order).

Depending on the ETFs, sometimes I do the purchase first and sometimes I do the sale first. Generally, I like to complete the transaction with the lower liquidity / volume ETF first.

My preference for completing the transaction on the ETF with lower liquidity / volume first is because if I had done it the other way round, I might be unable to complete the second transaction at a reasonable trading transaction cost (due to undesirable bid-ask spread).

Random list of previous posts:

Prior to conversion

My VEIEX holding is in the taxable account with Vanguard. From the prospectus, it is stated that:

If you convert your conventional shares to ETF Shares through Vanguard Brokerage, all conventional shares for which you request conversion will be converted into ETF Shares of equivalent value. Because no fractional shares will have to be sold, the transaction will be 100% tax-free. Vanguard Brokerage does not impose a conversion fee over and above the fee imposed by Vanguard.

I was especially curious about the “100% tax-free” part because it implies that VBS must be supporting some kind of fractional share tracking. I sent Vanguard a secure email, asking specifically if VBS supports the trading of partial ETF shares. The following is their reply:

With regard to your question, depending on the conversion rate of the fund, it could be possible for you to end up with fractional shares of an ETF. In order to sell fractional shares in your brokerage account, you would need to sell your entire whole share position in the given security. Any remaining fractional shares will automatically be sold on the settlement date of the transaction, which is normally three business days after the trade date. For example, if you own 500.346 shares of XYZ Inc., you would simply enter an order to sell 500 shares of XYZ. When the trade settles three business days later, the fractional shares are automatically liquidated and no additional commissions are charged.

I think their reply is reasonable: VBS does not support the trading of partial shares; but if you sell the entire holding, the partial shares will be liquidated automatically without any additional charge.

Note: I asked the same question on the Bogleheads forum and received answers from jeffarvon and stan1 even before Vanguard replied.

The conversion

I called up Vanguard Flagship service on a Wednesday morning and told the rep what I wanted to do. He first made sure that I already have a VBS account and then transferred me to the VBS department. The VBS rep confirmed the following:

• No fees for the conversion for Flagship clients.
• The conversion is completely tax free. Vanguard will exchange fractional shares if necessary.

I was also told that I can enter the cost basis of the tax lots into the system at VBS after the conversion. The tax lots can be broken into fractional share if necessary. I told the rep to go ahead with the conversion.

On Wednesday night, I noticed my VEIEX holding was zeroed out. Under the “Transaction History” tab, an entry with transction type “Conversion from” was added. The mouse-over balloon shows the information on the conversion prices (for VEIEX and VWO) and the number of shares of VWO I would get. At this point, the VWO shares have not been deposited into my VBS account.

On Thursday night, the correct number of VWO shares were deposited into my VBS account.

After the conversion

What that is left for me to do after the conversion is to enter in the tax lot information. I had already prepared this information before hand and calculated the equivalent number of VWO shares for each tax lot in a spreadsheet.

To enter the cost basis, I clicked on the “Cost Basis” link under the VBS account, and then followed by the “Enter cost” link. This takes me to the following page:

By default, only five lines for data entry are available but more lines can be added by using the “save and insert more lines” link. I successfully entered in 32 tax lots. After I submitted the information, it took one business day for the data to be updated.

Overall, the conversion process was done without any hiccups. The most painful part was actually for me to get information of the 32 tax lots and then enter them into the system.

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The calculator below will find the breakeven point which will make it worthwhile to perform the mutual fund to ETF conversion. The calculator inputs are as follows.

1. The conversion fee, currently $50. Enter 50.
2. The ETF expense ratio saving. For example, VEIEX ER=0.37% and VWO ER=0.25%. The difference is 0.12%, enter as 12.
3. The investment horizon in years.
4. The expected annual return. If the expected annual return is 8%, enter 8.

When the investment amount to be converted is higher than that calculated, a conversion would be worthwhile (assuming the assumptions are true). Note that as mentioned in the previous post, taxes are not considered in the computations.

ETF Conversion Decision Calculator

Random list of previous posts:

Why convert?

1. The main reason why an investor would want to convert mutual fund shares to the ETF class is because the expense ratios of ETF shares are lower than the investor class mutual fund shares. For example, the Vanguard emerging markets index mutual fund VEIEX charges 0.37% annually while the ETF version VWO charges only 0.25% a year.
2. A second reason is the possibly better tax efficiency in terms of capital gains distributions.
3. The third reason is the redemption fees savings. For certain mutual funds with redemption fees (most notably VEIEX and VTMGX), converting mutual fund shares to the ETF class and then selling the ETF shares would save a bundle on the redemption fees (0.5% for VEIEX and 1% for VTMGX shares owned for less than 5 years), especially if the amount is substamtially more than $1000.

Why not to convert?

1. If an investor already owns admiral shares of the mutual fund, there is little (if any at all) saving in the expense ratio. For example, the admiral class of Vanguard’s emerging market index fund VEMAX and VWO both charges the same 0.25% expense ratio a year.
2. ETFs could trade at a premium or discount, in addition to a trading spread (trading spread is the difference between the bid and asking prices). A person investing in mutual fund shares does not have to be concerned with purchasing or selling shares trading at a premium or discount, nor be concerned with the cost associated with the trading spread. Mutual funds shares are bought and solt at NAV (net asset value).
3. If an investor is contributing regularly, purchasing the mutual fund “generally” has no transaction fee while purchasing an ETF would normally entail a brokerage commission charge (unless the investor is using a free-trade broker). The brokerage fees could add up quickly to a substantial amount. Note: I say “generally” because one mutual fund exception is VEIEX, which charges a 0.5% purchase fee.

The case for VEIEX to VWO conversion

After looking at the pros and cons, let’s examine the specific case for VEIEX to VWO conversion.

Expense ratio saving. If an investor is holding a substantial amount of VEIEX (say from the low four digit range onwards), there is definitely a saving when the holding is converted to VWO. The current expense ratio saving is 0.37% – 0.25% = 0.12% or 12 bps (bps = basis points) per year. This difference, compounded over many years, could become substantial.

To see if this expense ratio saving really does make a difference in the performance numbers, let’s look at the historical performance of VEIEX and VWO for the years ended Oct 31, 2006 and 2007 (values taken from the prospectus):

Clearly, VWO outperformed VEIEX by 0.19% in both 2006 and 2007, the first two full years of its existence.

Trading spreads. There could be a trading spread cost in selling VWO in the future during the withdrawal phase. However, from my observations, the trading volume and liquidity of VWO has been improving through the months. The impact of trading spread cost should be relatively low. Furthermore, a 12 bps expense ratio difference a year would turn into (1.0012^20)-1 = 2.43% difference in 20 years time. This should mitigate any trading spread cost.

Redemption fee. Converting the mutual fund shares to the ETF class is one way to avoid the 0.5% redemption fee.

Conversion fee. As already mentioned, Vanguard charges a $50 conversion fee unless the investor is a Flagship client. Below, we will briefly look at how this fee would affect the conversion decision.

In the analysis, assume that the $50 fee to pay for the conversion comes out from the original VEIEX investment (tax consequences not considered for simplicity). Let R be the approximate investment return a year, X be the original investment amount and N be the number of years the investment is held.

Then the value of the investment after N years, would be given by

• X*(1+R-0.0012)^N for VEIEX
• (X-50)*(1+R)^N for VWO

For VEIEX, the compounding rate is reduced by the expense ratio difference of 0.0012 a year. For VWO, the original investment amount is reduced by $50 due to the conversion fee.

For the conversion to be worthwhile, we require (X-50)*(1+R)^N to be larger than X*(1+R-0.0012)^N. For example, if R = 0.1 (10% return a year), N = 10 years, solving the inequality gives X > 4606. This means that given the assumptions, it is better to convert if the original investment amount X is at least $4606.

Other scenarios are given in the table below.

Summary

It appears that for my situation, it makes a lot of sense to convert my VEIEX holding to VWO. This is especially so given that the investment is in the mid five digit amount and the conversion will be free for me. For investors who have to pay the conversion fee, the table above may help to decide if paying the $50 fee is worthwhile.

Random list of previous posts:

In my opinion, this ETF appears to be the closest thing to the “emerging market” “smallcap” and “value” asset class available currently to retail investors (I do not consider DFA funds to be easily available to retail investors). According to the fact sheet [PDF], this ETF has an expense ratio of 0.63%, which I think is quite reasonable considering the equity markets it is targetting.

The top 10 countries, as of Oct 26, 2007, were

This ETF has a dividend yield of more than 4%. From my experience with the VWO ETF, a significant portion (say 40%) will probably be considered as not “qualified” for the lower dividend tax rate by the IRS. As such, this fund will not be very tax efficient in held in a taxable account.

At the time of this post, this ETF is trading with a spread of four cents, with the asking price at $51.62 and bidding price of $51.58. Taking the NAV to be $51.60, the “spread cost” is a very reasonable 0.02/51.6 = 0.039%.

The figure below shows this morning’s trading action (up until the time of this post):

I will be watching this ETF closely to see if it fits into my existing portfolio.

The related Bogleheads discussion can be found HERE.

Random list of previous posts:

After I received the 1099DIV form from Sogoinvest, I noticed that all the dividends are classified as ordinary dividends, none of them are classified as qualified dividends. Also, for my VWO (Vanguard Emerging Market ETF) holding, the foreign taxes paid are not declared in the 1099DIV form. I know these are incorrect because the same ETF holdings held at Ameritrade had qualified dividends and foreign taxes paid declared in the 1099DIV form.

These incorrect figures are not good for me or investors in general because the tax rate for a qualified dividend distribution is typically only 15%, whereas the tax rate for an unqualified dividend can run as high as 35%. In addition, any foreign taxes paid by the fund can be claimed back as a credit in the tax return, dollar-for-dollar.

I requested Sogoinvest through their secure message system to issue me an updated 1099DIV. Here’s their “canned” reply:

We will look into this, the 1099 statements reflect what the IRS gave to us. So we will look into this and get it corrected if it needs to be as soon as possible.

Huh? I thought it is Sogoinvest who reports the dividend information to the IRS instead of the other way round? Anyway, I did not try to argue with them on this point.

I was not hopeful that I would get an updated 1099DIV on time, but there is nothing much I could do but to wait for an update. I also sent them a reminder some time after my original request. Then came April 14, but nothing. In the end, I filed my taxes without an updated 1099DIV, paying more in taxes than I actually need to. By my estimate, I probably paid about $50 more in taxes because of the inaccuracies in the 1099DIV form generated by Sogoinvest.

I do not know if this is an isolated case of an incorrect 1099DIV form, but if the qualified dividends and foreign taxes paid are generally not reported by Sogoinvest, then it will be a very big turn-off indeed.

Related links [1] [2] [3].

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Related post HERE.

Random list of previous posts:

You will be surprised by the amount of information covered. For a start, here is a list of topics in the library:

Table of Contents

I.References
A. Glossary
B. Investing: For Beginners
C. Books
D. Academic Research Links
E. About Vanguard and its Founder

II.Asset Allocation
A. Asset Allocation
B. Asset Location
C. Risk, uncertainty and behavioral pitfalls

III.Asset Classes

A. Equity
(a.) US Stocks
(b.) International Stocks
(c.) REITS
(d.) International REITS

B.Fixed Income
(a.) Bonds
(b.) TIPS
(c.) High Yield Bonds
(d.) Convertible Bonds

C. Alternative
(a.) Commodities

IV.Portfolio Management
A. Active vs. Passive Investing
B. Taxable account investing
(a.) ETF
C. Retirement and tax deferred investing
D. Rebalancing
E. Withdrawal Strategies

Random list of previous posts:

I think this spread is very reasonable for a new ETF. Assuming that the NAV is somewhere in between the ask and bid prices, the ‘purchase fee’, which does not include commissions if you are currently not enrolled in a free trade program, is about 0.04/51 = 0.08%. This is far lower than the 0.25% purchase fee if you are buying the mutual fund version (ticker VFWIX) directly from Vanguard. As a side note, the ETF version also has a lower expense ratio of 0.25% compared to 0.40% for the mutual fund version.

The intraday chart of the VEU versus iShares EAFE ETF (ticker EFA) is shown below.

For those who are interested , the following link contains the first day’s trading action: 2007-03-08-veu-trades.png. You can look at the ask-bid spreads over the first trading day. All the times at in Pacific Standard Time.

I think this ETF will become a keeper for investors, especially in the taxable account, for the following two reasons:

• ability to claim back foreign tax credit, and
• ability to tax harvest as and when needed, without the trading limitations and purchase / redemption fees associated with mutual funds.

What do you think?

Random list of previous posts:

For the mutual fund version (ticker VFWIX), the expense ratio is 0.40%, with a purchase fee of 0.25%, and a redemption fee of 2% if sold within two months. The expected date of offering is March 8, 2007.

For the ETF version (ticker VEU), the expense ratio is 0.25%. The expected date of offering is March 2, 2007. Usual brokerage fees apply if you do not have access to a free trade program.

The mutual fund version, with the purchase fee is not appealing to me at all but the ETF version does. Compared to the iShares MSCI EAFE ETF (ticker EFA, ER 0.35%), this new ETF would cover the equity market of the entire world except the US. This means that it also includes Canada and emerging markets which EFA doesn’t. In addition, it also comes with a lower price tag than EFA.

Hopefully, this fund would have a respectable trading volume when it debuts on Friday.

Random list of previous posts:

There are certain advantages in using ETFs instead of mutual funds; some of which are better tax efficiency, lower expense ratios and no redemption fee / trading restrictions. Currently, the core of my portfolio is invested in Vanguard mutual funds, but this could change in future as I am thinking of using more ETFs in my portfolio, especially for some of the more relevant asset classes.

I looked around to find the ETF vehicles of the asset classes that I currently hold. The following is the list for my equity asset allocation:

• US Total Market : Mutual Fund = VTSAX (Vanguard Total Stock Market Index Admiral, ER = 0.09%), ETF = VTI (Vanguard Total Stock Market ETF, ER = 0.07%).

• US Small-cap : Mutual Fund = VTMSX (Vanguard Tax-managed Small-cap, ER = 0.14%), ETF = VB (Vanguard Small-cap ETF, ER 0.10%) or IJR (iShares S&P 600 index, ER 0.20%, higher trading volume) in taxable account or VBR (Vanguard Small-cap Value ETF, ER = 0.12%) in tax-advantaged account.

• US Real Estate : Mutual Fund = VGSIX (Vanguard REIT Index, ER = 0.21%), ETF = VNQ (Vanguard REIT ETF, ER = 0.12%) in tax-advantaged account only.

• Int’l Large-cap : Mutual Fund = VTMGX (Vanguard Tax-managed International, ER = 0.20%), ETF = Vanguard’s up-coming international fund that tracks the FTSE All-World ex-USA Index (expected ER = 0.25%). Current substitute is iShare’s EFA (ER = 0.35%).

• Int’l Small-cap : Mutual Fund = VINEX (Vanguard International Explorer, ER = 0.43%), ETF = SSgA’s up-coming SPDR S&P World (ex-US) Small Cap ETF. Current poor substitute is Wisdom Tree’s DLS (ER = 0.58%).

• Int’l Emerging Markets : Already using ETF, which is VWO (Vanguard Emerging Market ETF, ER = 0.30%).

• Precious Metal Equity : Mutual Fund = VGPMX (Vanguard Precious Metals and Mining, ER = 0.40%), Current poor substitue is Market Vectors Gold Miners ETF, GDX (ER = 0.50%).

• Healthcare : Already using ETFs, which are IHF (iShares DJ US Healthcare Providers ETF, ER = 0.48%), PBE (Powershares Biotech and Genome ETF, ER = 0.6%) and XPH (State Street SPDR Pharmaceuticals ETF, ER = 0.36%).

Random list of previous posts:

The Dow Jones Wilshire Ex-US Real Estate Securities Index is a float-adjusted market capitalization weighted index that defines and measures the investable universe of publicly traded real estate securities in countries outside of the US.

I had previously invested in the Fidelity International Real Estate fund (FIREX) but got rid of it for its very poor tax efficiency. Hopefully, this ETF would prove to be a better vehicle for a taxable account.

Random list of previous posts:

After about six and a half years, SPY has finally reached this price. It closed at $139.61 today.

Random list of previous posts:

The objective of this ETF is to allow retail investors an easy way to gain access to private equity investments. Private equity investment is considered by many as an “alternative” asset class. I had previously written a post on private equity investments when the SEC filing for PSP ETF was made. Now that the ETF has started trading and its holdings are disclosed, let’s look at it in more detail.

According to this article, which was published before the PSP ETF launch, there are three ways to gain access to private equity investments:

1. Investing in Private Equity Funds: Investors can get exposure to private equity investment through investing in a partnership specializing in private equity. When an investor commits to a private equity fund, the commitment is typically to provide cash to fund on notice from the general partner. Redemptions and transfers usually are subject to strict limitations; it is not uncommon for general partner consent to be required for all transfers/redemptions and for the
   general partner to have complete discretion with respect to granting such consent.
2. Investing in Private Equity Fund of Funds: Investors can also get exposure to private investment through a pooled fund vehicle, fund of private equity funds. The advantages of investing in fund of funds are greater diversification, access to top fund managers, less cash commitment and reduced due diligence work. The drawback of investment in fund of funds is that investors may have to bear two layers of fees, at both fund level and fund of funds level.
3. Directly Investing in Private Companies: The third way available for investors to gain access to private equity investment is direct investment in privately held companies. However, compared with investing through funds it requires more capital (to achieve similar diversification and exposure), a different skill set, more resource and different evaluation techniques. This strategy is only suitable to experienced private equity investors. For most investors, the use of private equity funds or fund of funds would be preferred.

This PSP ETF seems to be variation from the second category (or it can be considered as a fourth category), whereby your money is not used directly by the company for making private investments; rather your money is used to purchased shares of companies that make private equity investments.

This will make the ETF behave somewhat differently from a true private equity investment, as the performance of the ETF will be affected by the way the stock market perceives how the listed company is doing, and could be affected by many other factors such as management changes at the listed company or general economic conditions.

Based on the above, I would therefore say that this ETF can be considered to give some characteristics of private equity investments but it is not a true private equity investment. Investors should therefore keep this in mind when considering this ETF.

Some other factors I looked look at include the following.

Tax efficiency. I expect that this ETF will be fairly tax efficient in terms of not distributing a lot of capital gains distribution since the fund manager can tax-swap to minimize on capital gains distribution. But, a look at the top few holdings suggest that the income dividend distribution could be quite significant. For example, the top holding American Capital Strategies, Ltd. (ACAS) has a 8% yield, most of which are in “unqualified” dividends. “Unqualified” means you have to pay tax at the full income tax rate, not the preferential 15% tax rate. Therefore based on information currently available, I would not think that this ETF will be very tax efficient.

Diversification value. True private equity investments should perform quite differently from general stock and bond investments. The following table shows the correlation of private equity investments with the S&P 500 and the bond market from 1990 to 2005.

However, as this ETF does not actually make private equity investments, rather it invests in listed companies that make private equity investments, I think its diversification value will be diminished. Besides, if you are invested in a total stock market fund, you already have some money invested in the listed companies held by this ETF.

Cost. This ETF has an expense ratio of 0.6%. This expense ratio is reasonable but certainly not cheap when compared to many of the sub-0.2% ETFs.

In conclusion, at this point, I am not convinced that I should add this ETF into my personal portfolio.

Disclosure: At the time of this writing, I do not have a position on PSP.

Random list of previous posts:

]]> http://www.indextown.com/archives/2006/10/26/a-closer-look-at-powershares-listed-private-equity-etf/feed/ 1 http://www.indextown.com/archives/2006/10/21/listed-private-equity-etf-starts-trading-on-oct-24/ http://www.indextown.com/archives/2006/10/21/listed-private-equity-etf-starts-trading-on-oct-24/#comments Sat, 21 Oct 2006 14:38:51 +0000 indexfundfan http://www.indextown.com/archives/2006/10/21/listed-private-equity-etf-starts-trading-on-oct-24/ Previously, I wrote about PowerShares’ intention to launch a ETF that invests in private equity. I received an email from PowerShares that this ETF (ticker PSP) will start trading on Tuesday, October 24, 2006. Unfortunately, there is no word on the expense ratio but I suspect it will be similar to other PowerShares products, at 0.6%.

Here’s the excerpt of the email:



Unprecedented Access to a Previously Inaccessible Asset Class

Until now, investing in private equity has not been accessible to most private investors. High minimum subscriptions, limited liquidity and transparency and largely closed access paths have been ongoing factors in keeping the private equity space nearly exclusive to institutional investors. With the development of the innovative Listed Private Equity Index^SM, which the PowerShares Listed Private Equitysm Portfolio is based, it is now possible to participate in the private equity marketplace through exposure to more than 30 U.S. publicly listed companies with direct investments in more than 1,000 private, innovative and promising businesses.

While this ETF does not appear to invest directly with private, promising businesses (instead it invests in companies that invests in private businesses), I am still watching this ETF with interest since private equity is an asset class which individual investors generally do not have easy access to.

By the way, as of June 2005, David Swenson has 17% of Yale university’s endowment fund invested in private equity investments.


Random list of previous posts:

]]> http://www.indextown.com/archives/2006/10/21/listed-private-equity-etf-starts-trading-on-oct-24/feed/ 0 http://www.indextown.com/archives/2006/10/08/breakeven-point-for-an-investment-in-sp500-index/ http://www.indextown.com/archives/2006/10/08/breakeven-point-for-an-investment-in-sp500-index/#comments Mon, 09 Oct 2006 04:11:23 +0000 indexfundfan http://www.indextown.com/archives/2006/10/08/breakeven-point-for-an-investment-in-sp500-index/ The recent highs of the Dow Jones Industrials Average prompted me to look into whether a lump-sum investment at the peak of the S&P 500 has reached the breakeven point. According to data from Yahoo finance, the S&P 500 reached its last peak on Mar 24, 2000, with a value of 1527.46 and the closing value of the S&P 500 on Oct 6, 2006 was 1349.59. This means that the ‘raw’ index has only reached 1349.59 / 1527.46 = 88.4% of its 2000 peak. It appears that there is more than 10% to go before the breakeven point is reached.

However, since the ‘raw’ index does not include dividends, the above conclusion is incorrect; we need to include dividends. To do this, and to use an investment easily understood and reproducible by investors (as opposed to just a hypothetical investment), I shall use the popular SPY ETF (expense ratio 0.10%) as a proxy for the actual investment returns obtainable by an investor if it were held in a tax-deferred account.



Using data from Yahoo finance, the “adjusted close” value (“adjusted close” means that the value is adjusted for dividend distributions) of SPY on Mar 24, 2000 was $139.23. The most recent closing value of SPY (Oct 6, 2006) was $135.01, or roughly 97% of the peak. This means that the breakeven point for a lump-sum investment in the S&P 500 made on Mar 24, 2000, will be reached if the index rises by another 3% or so.

The effect of dividend distributions can be observed in the attached figure. In the figure, the ‘raw’ index values (in blue) are given on the left axis and superimposed on the right axis are the ‘dividend-adjusted’ values of the SPY ETF (in green). We can see that dividend distributions have significant effect on the returns of the investment. These should never be ignored when comparing an investment’s performance with a given index.


Random list of previous posts:

]]> http://www.indextown.com/archives/2006/10/08/breakeven-point-for-an-investment-in-sp500-index/feed/ 3 http://www.indextown.com/archives/2006/10/04/dow-at-new-high-and-dividend-distributions/ http://www.indextown.com/archives/2006/10/04/dow-at-new-high-and-dividend-distributions/#comments Wed, 04 Oct 2006 15:43:25 +0000 indexfundfan http://www.indextown.com/archives/2006/10/04/dow-at-new-high-and-dividend-distributions/ I think by now many people are probably already aware that the Dow Jones Industrials Average (DJIA) Index closed on a new all-time high of 11,727.34 on Oct 3, 2006. The previous highest close was 11,722.98, reached on Jan 14, 2000.

While the new high is only some 0.0372% higher than the number set six and a half years ago, it is incorrect to conclude that had an investor invested $100,000 in the DJIA companies back in Jan 14, 2000, he would now be back to square one, i.e. roughly breakeven on the investment ($100,037.20). This is because the index itself does not adjust for the effect of dividends.

To see this, let’s use the example of the DIAMONDS ETF (DIA), which specifically invests in the Dow companies. Using data from Yahoo finance, on Jan 14, 2000, DIA closed at 117.50 and on Oct 3, 2006 it closed at 117.14. (In fact, if we just looked at the raw numbers, DIA actually closed lower on Oct 3, 2006 than on Jan 14, 2000! This is probably due to the effect of expenses incurred by the fund; but this is not the main point of this post.) But if we take dividend distributions into account, the picture is different.

To take dividend distributions into account, we have to dig up the dividends distributed by DIA through the six and a half years. However, there is an easier way; you can view this information from Yahoo finance since it conveniently adjusts for the effect of dividends. This is shown in the last column of the attached figure.



To get the full picture, we note that the adjusted close of DIA on Jan 14, 2000 was $103.52. It closed at $117.14 on Oct 3, 2006. So the gain is 13.16% for the six and a half years. In other words, if you had put $100,000 in the DJIA companies in a tax-advantaged account on Jan 14, 2000, you would now have roughly $113,160. Not a big gain, but far better than the $100,037.20 had we not properly accounted for the dividends.

Note that this “quirk of index construction” is sometimes used by indexing-bashers to confuse investors that investing in index funds gets you nowhere after ‘X’ number of years. But the fact is, the raw index numbers usually does not include dividend distributions, and does not tell the true story.

Update:

DIA’s adjusted close on Jan 14, 2000 was $103.52. The next high for DIA’s adjusted close was on Dec 21, 2004 at $103.55. So the DIA ETF first broke the breakeven point on Dec 21, 2004.


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]]> http://www.indextown.com/archives/2006/10/04/dow-at-new-high-and-dividend-distributions/feed/ 2 http://www.indextown.com/archives/2006/09/16/proshares-files-for-22-new-etfs/ http://www.indextown.com/archives/2006/09/16/proshares-files-for-22-new-etfs/#comments Sat, 16 Sep 2006 21:39:19 +0000 indexfundfan http://www.indextown.com/archives/2006/09/16/proshares-files-for-22-new-etfs/ ProShares, the company famous for its long and short funds, has filed with the SEC to introduce ETFs that covers 22 different slices of the market. For each slice, ProShares is planning to introduce three “flavors”: the “Ultra, Short and Ultrashort” versions.

According to the filing, The “Ultra” version is a market long version that aims to match 200% of the benchmark. The remaining two are market short versions; “Short” aims to match 100% of the inverse of the benchmark and “Ultrashort” aims to match 200% of the inverse of the benchmark.

Taking taking into account three “flavors” for each slice, this gives a total of 66 ETFs. I expect these ETFs to be expensive, in line with the expense ratio of 0.95% that ProShares is currently charging for its funds.



It looks like as the ETF competition gets more crowded, more and more of the new ETFs do not add any value to the retail investor.

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