by Tom Taulli | December 14, 2012 11:08 am
ETFs vs. mutual funds — it’s one of Wall Street’s biggest fights.
It’s true that many more mutual funds have the advantage of active management — thus a top investor like Peter Lynch or Michael Price can have a huge impact on returns. But such superstars are rare, preferring instead to operate hedge funds, where fees are much higher. More importantly, ETFs are starting to get into the actively managed world themselves.
That said, if you’re a 401k investor, you don’t really have a choice. It’s mutual funds or bust.
But if you trade through an IRA or another personal brokerage account, you do have a choice. And that’s where ETFs strut their own big advantage: low costs. More often than not, you can get the same kind of flavor (and return) in an ETF for much less in expense fees and other charges than you’d get in another mutual fund.
Here are a few examples of where investors would’ve made out better with a lower-cost ETF without sacrificing performance:
Mutual Fund: BlackRock Equity Dividend
Replacement ETF: Vanguard Mega Cap 300 Value Index
The BlackRock Equity Dividend (MUTF:MDDVX) is a dividend-focused large-cap fund, and a popular one at that, with $25 billion in assets.
The fund takes a conservative, long-term approach to investing, as reflected in its scant 3% turnover ratio. Top holdings include Chevron (NYSE:CVX), Wells Fargo (NYSE:WFC), JPMorgan (NYSE:JPM) and Exxon Mobil (NYSE:XOM). And had you gotten into MDDVX at the beginning of the year, you’d be looking at 12.31% returns for the year, which includes a 1.96% dividend yield.
Had you gotten into the Vanguard Mega Cap 300 Value Index ETF (NYSE:MGV), you’d be doing even better.
MGV is a similarly focused fund with big holdings in Chevron and Exxon, as well as AT&T (NYSE:T) and General Electric (NYSE:GE). To date, MGV has returned 15.27% — more than 200 basis points better. That’s thanks in part to a superior dividend yield of 2.78%, but also just 0.12% in expense fees, compared to nearly 0.98% for MDDVX.
And don’t forget, MDDVX also requires hefty 5.25% front-end load charge.
Mutual Fund: RidgeWorth Intermediate Bond
Replacement ETF: Schwab U.S. Aggregate Bond ETF
Low expenses are critical for bond funds, which have to deal with extremely low yields. So every basis point counts.
Take a look at the RidgeWorth Intermediate Bond (MUTF:IBASX). The fund yields 1.42% but charges 0.62% — in total, it has returned 3.13% for 2012. That doesn’t include a 4.75% load charge.
Investors instead could have gone with the Schwab U.S. Aggregate Bond ETF (NYSE:SCHZ) — with the same focus on intermediate-term investment-grade bonds — which has returned more than 4% despite yielding a little less at 1.3%, thanks in large part to its scant 0.05% in fees.
Mutual Fund: Wells Fargo Advantage Emerging Markets
Replacement ETF: WisdomTree Emerging Markets
When it comes to long-term growth, emerging markets provide huge opportunities. But it can be expensive for a mutual fund to engage in analysis and research.
This is the case with the Wells Fargo Advantage Emerging Markets (MUTF:EMGAX) fund, which has investments in countries like Brazil, South Korea, Taiwan, Mexico and China. The fund has returned 9.5% this year, hampered by a hefty 1.68% in fees. Plus, you’d be suffering an initial 5.75% load on its A shares.
The WisdomTree Emerging Markets Equity (NYSE:DEM) ETF is similar to EMGAX in that it’s focused on conservative emerging-market investments, which tend to have lower returns. DEM’s 2012 return is 10.25%, and while that isn’t remarkably better than Wells Fargo’s mutual fund, it is better — and that’s because of a much lower expense ratio of 0.63%.
Mutual Fund: CGM Realty
ETF Replacement: Vanguard REIT Index
By looking at the 8% total return of the CGM Realty (MUTF:CGMRX) fund — which leverages high-yielding REITs — you would think the real estate market had a tough time in 2012.
However, the Vanguard REIT Index ETF (NYSE:VNQ) — which tracks the MSCI US REIT Index, spanning small-to-large-cap REITs — did much better, with a gain of 15.4%.
Part of it was fund manager Ken Heebner’s choice of stocks, but also adding to that disparity was 0.88% in expenses for CGMRX vs. just 0.1% for VNQ. That said, you at least didn’t have to pay even more up front for that underperformance — CGMRX mercifully does not charge a load fee.
Mutual Fund: Davis Financial
Replacement ETF: Financial Select Sector SPDR
2012 has been a standout year for financial stocks. While the U.S. economy still is cobbling together a sluggish rebound, bright spots like real estate and auto sales have really driven up demand for loans.
But depending on how you invested in financials, you might not have seen your fair share of returns.
Davis Financial (MUTF:RPFGX) is a mutual fund that focuses primarily in financial services stocks like American Express (NYSE:AXP) and Wells Fargo. However, as a hedge against volatility, RPFGX invests in a number of non-financials, including names like energy firm Canadian Natural Resources (NYSE:CNQ), pharmacy giant CVS Caremark (NYSE:CVS) and even search-engine titan Google (NASDAQ:GOOG).
The fund has returned a market-beating 17% in 2012, and charges 0.91% in fees. A-class shares also require a 4.75% load.
However, it was weighed down in comparison to the Financial Select Sector SPDR (NYSE:XLF), which charges just 0.18% and has returned 25% for the year to date.
In this final case, however, it’s also important to point out that the disparity was caused by much more than fees. This is what can happen when a fund that says it’s about a certain category, but veers into other sectors. RPGFX’s interest in other categories might shield it during poor times for financials, but if you’re banking on a bull run for financials, the XLF is a truly representative play that will win out, time and time again. So don’t just look at fees — look at what’s inside the fund.
Tom Taulli runs the InvestorPlace blog IPO Playbook, a site dedicated to the hottest news and rumors about initial public offerings. He is also the author of “How to Create the Next Facebook” and “High-Profit IPO Strategies: Finding Breakout IPOs for Investors and Traders.” Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.
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