Click on this link, ETF scorecard, to download a spreadsheet-program for appraising the strengths and weaknesses of an exchange-traded fund (ETF). The program is not designed to appraise mutual funds, exchange-traded notes, and closed-end funds. If the program gives an incorrect appraisal, please send a comment at the end of this article and I will make an appropriate update. The latest version is dated 7/18/2012.
The ETF scoreboard is programmed to:
- recommend a general trading strategy appropriate for the ETF’s primary risk
- guide you through the fund’s prospectus and/or annual report with a sense of purpose
- provide a no-cost rating that’s independent of vendors’ fee-only ratings 1,2
The do-it-yourself ETF Scorecard requires you to enter essential information from easily accessible regulatory documents. That information is automatically translated into a profile of risks and benefits. The famous ETF called “SPY” is used as an example. Begin by opening the program to the SNAPSHOT spreadsheet.
The first column lists the information that can be found in websites (next paragraph). The second column contains “INPUT CELLS” that are white for keyboard entries –“(click here to make an entry)”– and black for multiple choice entries –“(click here for drop-down list)”–. A third column of “WARNINGS” (not shown) contains error messages that disappear when the required information is entered.
Websites. Open the home page of XTF.com1 and type the ETF’s trading symbol (in this example it’s SPY) into the Search cell in order to access the appropriate Ratings tab. There you will find the ETF symbol, ETF name, inception date, geography, underlying index, index composition (weighting), and (majority) asset class. The sub tab Structural integrity provides the date of information, legal structure, annual yield, and net asset value. The sub tab Fund holdings provides an accounting of the majority of assets which is useful for the investor, but not a required entry.
Now open the Welcome page of Morningstar.com 2 and type SPY into the Quote cell in order to access the quote page. The Quote tab provides the ETF’s name and symbol, today’s total assets (an approximation of net asset value), and top holdings (an informative accounting of the majority of assets). The Fees & Expenses tab provides the recent net asset value, primary benchmark (Index), (portfolio) turnover ratio, leverage, (annual) 12 month yield, legal structure, inverse/short, investment strategy, and inception date. The Filings tab provides access to the prospectus and annual report filed with the SEC. The filings usually provide additional information about the minority of assets, portfolio diversification, and tax structure. The filings also provide more detailed information about the investment strategy, portfolio management, and risks of investment.
Risks and benefits. Turn to the SCORECARD spreadsheet to read the program’s appraisal of SPY.
- Net worth- Funds with very low net asset value are at high risk for an unplanned termination of operations 3,4. More information is available in the article on fund experience and size.
- Strategy- The widely accepted strategies of “replication” and “sampling” are forms of passive management that seek to match the performance of the fund’s benchmark index. Higher-risk strategies involve the use of derivatives and/or active management to either underperform or outperform the benchmark index. Information is available in the article on investment strategy.
- Experience- Inexperienced management may enhance any losses incurred by high-risk strategies.
- Tax burden- Taxes on ETF returns are paid by the shareholder unless the ETF is held in a tax deferred brokerage account. More information is available in the article on tax burden.
- Tax advantage- Most passively managed ETFs have a tax advantage over mutual funds by avoiding unrealized capital gains.
- Portfolio- The fund’s legal structure determines whether the investment portfolio is “managed” or “unmanaged”. A managed portfolio is more likely to commit an investment error than an unmanaged portfolio. The managed portfolio can incur risks of lending, borrowing, and rebalancing assets to the extent that management error reduces the fund’s net asset value and subsequently reduces the share price in the stock market. Supplemental information is available in the article on management.
- Asset risk- The majority of the portfolio’s assets form a unique risk of investment. The minority of assets may contribute to management error when used for hedging purposes. A brief description is given in the article on assets.
- Geographic region- Funds that invest in foreign markets provide diversification to the shareholder’s investment portfolio. But foreign markets are risky with respect to the fluctuation of currency exchange rates, possible nationalization of private companies, and a variety of trading barriers.
- Index- The Index is constructed by use of one or more weighting factors that affect the index value. The weighting factors also affect the investment performance of passively managed ETFs.
The table of PRIMARY RISK AND BENEFIT renders an opinion about the main disadvantage and advantage of investing in the ETF.
The Fund’s PRIMARY RISK of uncertain investment returns is selected from the following risk factors that are listed in a descending order of priority:
- A portfolio of derivatives (e.g., ‘geared’ fund, leveraged fund, inverse fund) with net asset value below $25 Million offers the greatest uncertainty of returns.
- Even without the portfolio of derivatives, a very small fund is at risk of unplanned termination.
- Either a portfolio of derivatives or an actively managed portfolio is a high risk investment.
- Fund’s that require special tax reports or have a high turnover of portfolio assets can increase the shareholder’s tax burden and erode the shareholder’s investment profit.
- The managed portfolio may acquire derivatives and/or illiquid collateral assets that diminish the net asset value.
- An inexperienced fund is at risk of making management errors that diminish returns.
- The capital markets of developed economies are less risky than those of emerging and frontier economies.
- The class of majority assets in the portfolio determines the shareholder’s returns. The uncertainty of returns varies among asset classes.
- The composition and fluctuation of the Index are strong determinants of portfolio composition and performance.
- The infrequent cash distributions of some funds can delay the shareholder’s opportunity to benefit from reinvested dividends (a familiar risk called “dividend drag”).
The PRIMARY BENEFIT of investing in an ETF is either the opportunity to trade ETF shares in the stock market or hold them as a long-term, frugal investment. This program assigns the trading opportunity to high-risk funds and the investment opportunity to comparatively low-risk funds.
The scorecard spreadsheet is programmed to automatically provide a risk-benefit analysis. You can edit the SCORECARD by un-protecting the spreadsheet (there is no password). For example, you might wish to edit the scorecard’s automated output for SPY by changing the phrase “infrequent cash distributions” to “quarterly cash distributions”. Beware that editing deletes the formula embedded in tan colored cells. If one or more cells are corrupted beyond use, simply start over by downloading a new scorecard and re-entering data into the SNAPSHOT spreadsheet.
This App is free software dedicated to the do-it-yourself appraisal of ETFs. There’s sufficient information in internet websites to perform the appraisal in a couple of hours. A broader discussion of the ETF Scorecard is available in Appraising ETFs with a scorecard.
Copyright © 2012 Douglas R. Knight
1. XTF ETF EXPERTS. © 2012 XTF Inc., all rights reserved. http://xtf.com/Ratings/
2. Morningstar®, © 2012 Morningstar, all rights reserved. http://www.morningstar.com/Cover/ETFs.aspx
3. J. Alex Tarquinio. Should more ETFs shut down? SmartMoney.com. ETF Watch, September 28, 2011. Copyright ©2012 Dow Jones & Company, Inc. All Rights Reserved http://www.smartmoney.com/invest/etfs/more-etfs-should-shut-down-1315932598095/
4. Ron Roland. ETF deathwatch criteria for 2011. InvestWithAnEdge.com. January 5, 2011. Copyright © 2012 · AllStarInvestor.com, Publisher of InvestWithAnEdge.com http://investwithanedge.com/etf-deathwatch-criteria-for-2011