Portfolio Impact and Fees of Exchange-Traded Funds

Whether you're using exchange-traded funds to build an efficient, low-cost portfolio or to opportunistically invest in certain market segments, portfolio construction matters. For instance, what index does the ETF track? How concentrated or sprawling is the portfolio? How does the fund weight its holdings? What biases does that approach introduce?

Determining the portfolio impact should help you determine how an ETF might, or might not, fit into an asset allocation strategy and what influence it might have on your portfolio's overall risk/reward profile.

Fees

Fees are a key differentiator in the ETF world; generally speaking, the lower a fund's expense ratio the better. For instance, are fees high or low in absolute terms? Cheap compared with open-end mutual funds? What about comparable ETFs?

ETF alternatives

There can be several ETFs that track the same or similar indexes. Analyzing similar funds will help you compare the pros and cons of these alternatives and assess if another fund would actually be a better fit for you. You will find that, oftentimes, several ETFs will claim to track the same index but use differing means to do so. Has the ETF product provided optimized the product for index replication, or does it focus on efficient market execution by using a sampling approach? Neither strategy is right for all investors; long-term investors tend to favor full replication while rapid traders favor the efficient execution that sampling provides. Determining your intended uses and the product's design are crucial in finding the right fund for you.