Sunday, August 24, 2008

Trading One ETF For Another

I have been planning on adding an emerging markets ETF to the index strategy of my portfolio. However, I've been reconsidering EEM from Barclays as the specific vehicle for doing so. Its expense ratio is unbelievably high for an ETF: 74 bps! Holy canole, that's almost as much as a typical actively-managed mutual fund. By comparison, VWO from Vanguard tracks the same index but at 25 bps costs only a third as much. Expense ratios matter very much when picking an ETF, because minimizing costs is the name of the game.

These two ETFs both have very deep option chains, so either will accomodate my strategy of using out-of-the-money options to add yield. It is true that sometimes these ETFs can briefly outperform or underperform their given benchmark due to tracking error and the way they sample the benchmark's components, but frankly that can't be helped. Brief periods of mismatching the benchmark don't bother me as much as wasting money on exorbitant expense ratios.

The edge from now on will go to VWO, so that's the one I will use in the future to get emerging markets exposure in my core portfolio.

Nota bene: Anthony J. Alfidi currently holds short calls on EEM but does not hold a long position in the underlying ETF. After these options expire in September 2008, Mr. Alfidi will replace EEM with VWO in his portfolio.