26 BARRON’S October 21, 2019
Funds
In-House ETFs May Not Be the Best Choice
ByLewisBraham
ANYONE TAKING A CURSORY LOOK AT THE JOHN HANCOCK MULTIFAC-
tor Emerging Markets exchange-traded fund would surely be
mystified. The fund is barely a year old, is lagging behind its
peers in 2019, and charges a 0.55% management fee—five times
thatofitslowest-costcompetitor,SPDRPortfolioEmergingMar-
kets.Yet,somehow,italreadyhasgathered$809millioninassets
inahypercompetitivemarketinwhichoverpricedETFsoftendie
a quick death.
Thesecretisthat97%oftheassetsintheHancockETF(ticker:
JHEM)comefromJohnHancockitself—orrather,itsparentcom-
pany, Manulife Investment Management.
It’spartofarecenttrendreferredtoasBYOA,for“bringyour
ownassets.”WhilemanyinvestorsregardlargerETFsasbetter
becausethey’reoftencheaper,havestrongperformance,andare
more liquid and therefore easier to trade, none of these things
maybetruewithin-houseETFs,becausetheyhaven’tgrownor-
ganically.Theissuersaremerelylookingtogainafootholdinthe
ultracompetitiveETFspace.Investorsshoulddiscountsizewhen
analyzing them.
House-brand ETFs can be harder to trade even if they are
largebecauseonlyoneinstitutionownsmostoftheirshares.“Do
I really want to be the second investor sitting across the table
fromonelargeinvestorthatmayormaynotcontinuetoallocate
to this product over the long term and, if they de-
cidetopulltheplugthenextday,I’mtheonestuck
holdingthebag?”asksBenJohnson,Morningstar’s
director of global ETF research.
Consider,forexample,thatsince98%of HartfordTotalReturn
Bond ’s(HTRB)$602millioninassetscomefromHartfordFunds
Management, it has a daily trading volume of less than 10,000
shares. By contrast, a slightly larger competitor, the $812 million
Fidelity Total Bond (FBND), trades over 100,000 shares daily.
Thisisnottosayin-houseETFsarebad,buttheyhaveanin-
herentconflictofinterestbecausetheirissuers’financialadvisors—
whoaresupposedtoputtheirclients’interestfirst—knowthattheir
employerwillbemoreprofitableiftheyfavorthemovercompeting
ETFs. The question becomes, are there better alternatives?
“Tome,thedifferentiatoriswhetherindependentETFduedili-
gencethatexaminedtheentiregamutoffundsavailableinapartic-
ularmarketsegmentwouldcometothesameconclusion,”saysElis-
abethKashner,FactSet’sdirectorofETFresearchandanalytics.
“TherearealotofbrandsthatcandesignanETFsselectionrubric
with criteria specifically geared toward making sure that brand’s
funds are selected by an ‘objective process.’ ”
KashnerpointstotheETF-selectioncriteriaatCharlesSchwab’s
robo-advisorSchwabIntelligentPortfolios.“AtthetimethatSchwab
Intelligent Portfolios was launched, Schwab ETFs often had the
lowestexpenseratios,butless-stellarliquiditythantheircompeti-
tors, lower volumes, and wider trading spreads,” she says. The
ETFs also had worse tracking error—how well they mimic their
benchmarks—whichshecallsthe“ultimatemeasureofcost”forin-
dexproducts.“Bywritingtheir[robo-advisorETFselection]criteria
toreallyfeatureexpenseratioovereverythingelse,theywoundup
in a situation where their robo picked the Schwab fund in every
market segment in which Schwab offered an ETF,” she says.
Inanemailedstatement,SchwabspokeswomanErinMontgom-
eryacknowledgedthatETFexpenseratioswereadrivingforce
in its ETF selection criteria, but she also noted that “Schwab’s
writtenparametersdonotallow[theadvisordivision]toconsider
compensationtoSchwaborotheraffiliatesinconnectionwithse-
lecting ETFs.”
At least low fees are a reasonable criterion. What can be said
about the $1.3 billion First Trust Utilities AlphaDEX (FXU),
which,accordingtoFactSet,is43%ownedbyFirstTrustAdvisors?
Itchargesa0.63%expenseratio,whileitslowest-costcompetitors,
Fidelity MSCI Utilities Index (FUTY) and Vanguard Utilities
(VPU), charge 0.08% and 0.1%, respectively. Fidelity’s and Van-
guard’sperformancehavecrushedFirstTrust’s,deliveringupward
of12%five-yearannualizedreturn,versusFirstTrust’s8.6%.First
Trust declined interview requests.
Manyin-houseETFsaremultifactoronesthatsimulateactive
management by owning stocks with attractive qualities, such as
low valuation or low volatility. There’s a case to be made that if
successful,suchETFsdeservehigherfees.Yetmosthaven’tout-
performed traditional index funds.
Oneexampleisthe$1.4billion FlexSharesMorningstarU.S.
MarketFactorTiltIndex (TILT),whichhasa0.25%expensera-
tioandis80%ownedbyitsparentcompany,NorthernTrustIn-
vestments.TheETFtiltstowardsmall-capandvaluestocksinthe
Russell 3000—two factors that have both underperformed—and
thus the ETF has, too, since its 2011 inception.
“We want exposure to small and value, recognizing that over
timethereisa[return]premiumforthosefactorsthatisverywell
documented,” says Katherine Nixon, chief investment officer of
Northern Trust’s Wealth Management division.
Yet to avoid lagging behind the market too much, the Flex-
SharesETFhasonly4%ofitsportfolioinactualsmall-capsand
stillholdstechdarlingssuchas Microsoft (MSFT)and Amazon-
.com (AMZN) that value purists shun. Given the fact that it has
trailed plain-vanilla ETFs like Vanguard Total Stock Market
(VTI),whichhasafarcheaper0.03%expenseratio,byoveraper-
centage point a year since inception, investors need to ask
whether the ETF is really worth it.
CashTrack,
pageM24