How to compare funds tracking the same index
You might come across exchange-traded funds (ETFs) that sound really similar on paper. So how do you tell the difference between them, and choose which you might invest in?
For example, there are a bunch of ETFs that try to match (or ‘track’) the performance of the S&P 500 index—like the Smartshares US 500 Fund or Vanguard S&P 500 ETF. Letʻs look at some ways to do your homework on an ETF, and figure out if it’s right for your portfolio.
First, gather info about the fund
To compare different ETFs tracking the same index, you might start by gathering some info about each fund. Dig into places like the fund manager’s website or the fund’s product disclosure statement (PDS) (sometimes called a prospectus).
Things to look at include:
The exchange the ETF is trading on—The exchange where the ETF is trading can impact things like the currency it’s trading in, market opening hours (when you can buy and sell), tax, and liquidity.
The ETF’s investment objective—What’s the ETF tracking and investing in? What is it trying to achieve? Is it investing directly in what it’s trying to replicate (like all 500 companies in the S&P 500 index), or is it investing in another ETF (an ETF that itself invests in the 500 companies in the S&P 500)?
Fees charged by the fund manager—Higher fees can cut into returns, and have a big impact on investment returns over the long term. One way to weigh up the cost of different ETFs is to compare expense ratios found in the fund’s prospectus or on websites like Yahoo Finance.
Who’s the fund manager?
As an investor, you might do your due diligence on the fund manager (the likes of Smartshares, Vanguard, and Blackrock), and ask:
Where is the fund manager based?
Are they well established and reputable?
Do they specialise in ETFs, or do they provide a range of investments?
What’s their track record? Have their funds historically done what they said they’d do (note that past performance isn’t a guarantee of future returns, but the info is available and worth considering)?
How has the ETF performed?
Two ETFs tracking the same index can have different unit prices, but comparing these prices is generally less important than comparing their performances (or returns).
To dig into the performance of each fund, you can look at:
Tracking—How closely has the ETF matched the performance of the index over time? Does this performance match the ETF’s investment objective?
Dividends—If dividends are important to you, you might consider whether the ETF paid dividends in the past. How does the ETF’s gross dividend yield compare with other similar ETFs?
What are the risks?
Different ETFs will have different risks. Remember, risk isn’t always a bad thing—it’s about understanding what the risks are, how they fit with your risk profile, and how they can be managed.
One of the key risks to consider is tracking risk (or tracking errors). This is when the performance of the ETF isn’t matching the performance of the index it’s tracking—and is therefore experiencing a lower rate of return. Tracking errors can be caused by things like:
the weighting of companies in the index changing, and the fund manager not being able to exactly match that change
foreign exchange fluctuations (if the ETF is in a different country to the index).
Some other risks to consider include:
Volatility—How frequently does the price of the ETF change, and by how much?
Currency—What currency is the ETF trading in, and is this different from your own currency? How might foreign exchange fees and rates impact returns? Is the ETF ‘hedged’ (protected from currency fluctuations), or ‘unhedged’ (exposed to currency fluctuations)?
Liquidity—How liquid has the ETF tended to be? The more liquid the ETF is, the faster and less expensive it is likely to be to convert an investment into cash.
Leverage—ETFs that are leveraged use complex financial products (called derivatives) or borrow money to amplify the returns of the ETF. These have added risk in that if the index the ETF is tracking drops in value, the ETF will drop in value by an even greater amount, and can lead to significant losses.
When it comes to comparing ETFs tracking the same index, there are lots of different things to consider. There’s no one-size-fits-all approach, so it’s all about doing your due diligence and considering what works best for you and your financial situation and goals.
Remember, past performance isn’t always going to be an accurate predictor of future performance.
Ok, now for the legal bit
Investing involves risk. You aren’t guaranteed to make money, and you might lose the money you start with. We don’t provide personalised advice or recommendations. Any information we provide is general only and current at the time written. You should consider seeking independent legal, financial, taxation or other advice when considering whether an investment is appropriate for your objectives, financial situation or needs.