Are ETFs that own other ETFs useful portfolio tools or do they undermine the asset allocation services provided by financial professionals? This is an important question to consider, especially as the number of ETFs owning other funds increases.
While the ETF category for “fund of funds” (FOF) is still small, it’s nonetheless steadily climbed over the past few years. In 2009 assets of $100 million have grown to almost $1 billion today. At the end of April, there were 23 FOF ETFs with $923 million in assets, according to the National Stock Exchange. The three largest ETF providers with the most assets in this category are iShares ($423 million), AdvisorShares ($200 million) and IndexIQ ($172 million).
Within the ETF universe, FOF products can be grouped into two basic categories: ( 1) target dated retirement funds, and( 2) strategy funds.
The retirement market is one place where the FOF ETF solution has real traction. “We use ETFs which are structured as fund of funds in our 401(k) program because such funds are packaged solutions at that people can understand,” states Daniel Weiskopf, principal at Forefront Advisory in New York City. “We believe that the first priority to solve part of the issue of getting people to buy into retirement programs is to structure programs that people can understand.”
Black Rock’s iShares unit offers seven FOF ETFs linked to target date benchmarks built by Standard & Poor’s.
The funds have target dates that begin with 2010 (TZD) and run in five-year increments all the way to 2040 (TZV).
The main asset classes represented inside S&P’s target indices are domestic and international stocks, domestic real estate, fixed income and cash. Each asset class is represented by a corresponding iShares ETF. For example, the 2020 ETF (TZG) holds the bulk of its market exposure to the iShares S&P 500 Index Fund (IVV) and the iShares Barclays Aggregate U.S Bond Index Fund (AGG) while the rest of the portfolio is allocated among the iShares Barclays Short Treasury Bond Fund (SHV), iShares Barclays U.S. TIPS Bond Fund (TIP), iShares MSCI EAFE Index Fund (EFA), iShares MSCI Emerging Markets Index Fund (EEM), iShares S&P Small Cap 600 Index Fund (IJR), iShares S&P Mid Cap 400 Index Fund (IJH), the iShares Cohen & Steers Realty (ICF) and cash.
The total all-in expenses for the iShares FOF target dated ETFs, after fee waivers, range from 0.29 to 0.30 percent annually.
In the long run, the best application for target-dated ETFs is within 401(k) plans, but paradoxically most employer sponsored retirement plans don’t offer ETFs. Despite these shortcomings, many analysts still see ETFs taking market share from traditional mutual funds in the 401(k) space.
The Dent Tactical ETF (DENT) is another example of an FOF ETF, but with a tactically oriented actively managed investment approach.
DENT aims for long-term capital growth by investing in other ETFs across several different asset classes such as domestic and foreign equities, domestic or foreign fixed income or commodities. Using Harry S. Dent Jr.’s research methodology, DENT’s portfolio manager analyzes economic and demographic analysis, the overall trend of the U.S. and global economies and consumer spending patterns. The manager tries to own the strongest performing asset classes and apply it to the fund’s target allocation.
Good as that may sound, DENT’s performance has struggled. Since its 2009 inception, it’s posted a 5.76 percent gain compared to a 27.90 percent gain for the S&P 500. DENT charges a net expense ratio of 1.50 percent.