That may seem like a lot, but compared to some offerings on the market these funds of ETFs can seem like a bargain. At the other end of the spectrum are groups like Arrow Investment Advisors, who utilize ETFs to execute active investment strategies. Arrow's flagship fund is the Arrow DWA Balanced Fund (DWAFX), a fund-of-ETFs that relies on a relative strength strategy to pick and choose different ETFs as asset classes come in and out of style.
In addition to loads and other charges, DWAFX levies a 1.75% expense ratio before you factor in the expenses for the underlying ETFs. According to the most recent prospectus, those ETF expenses would add an additional 39 basis points to the total fee. Fortunately, Arrow caps expenses at 2% for the strategy. But still, paying 2% to hold a family of ETFs that charge 39 basis points is a far cry from the low-expense strategy most people associate with ETFs.
True EoEs
The next big leap will come soon: true "ETFs of ETFs," or EoEs. There are not currently any EoEs in registration, much less on the market, but there are a number of companies looking at the space. Although these companies are keeping a low profile for now (all refused to comment publicly for this story), we are certain to see the first EoE filing by the end of the year. Companies are generally pursuing two approaches: tactical asset allocation strategies that shift exposure between different sectors or asset types based on market trends, and straight asset allocation funds that combine different assets into a one-stop-shopping experience. The challenge for the latter is to keep fees low enough to make the rebalancing benefits worth the extra costs; if they can do that, the asset allocation EoEs could be a hit.
Do They Make Sense?
The question of whether these products make sense is really two-fold. First, you have to ask whether funds-of-funds make sense. And then you have to ask whether ETFs are better or worse instruments than traditional active funds for the fund-of-fund structure.
The first question is really beyond the scope of this article. Funds-of-funds is a popular product structure, and they come with advantages and disadvantages. On the plus side, they offer instant diversification and a regular rebalancing schedule-both of which are unmitigated goods for a smart investment portfolio. On the flipside, they layer fees on top of fees, taking a low-cost strategy and often multiplying its expense ratio many times. XTF Advisors, remember, plans to charge approximately 1% per year for a package of ETFs that cost just 18 basis points on their own. It's up to the individual advisor or investor to determine whether the additional 82 basis points is a fair price to pay for the rebalancing schedule, although it seems like a smart advisor could execute the same strategy for most clients at a lower cost.
These new products also come at a time when advisors are being inundated with new ETF products on almost a daily basis. "When you see everybody and their dog has a new shell out there, I'm a little skeptical," says Penny Marlin of Marlin Financial in Delray Beach, Fla.
Although Marlin feels a fund-of-fund structure for ETFs could potentially bring benefits, she plans to wait until the products build up a track record before considering them for her clients.
Marlin, however, feels the 1.75% expense ratio of the Arrow DWA Balanced Fund is too high, and questions what the tax impact will be of the fund's active management strategy. Murphy of TEMMA Financial agreed, saying, "That would be way too expensive. It would be very hard to get the excess return to overcome that kind of expense ratio."
There is also a clear drawback to funds of funds when it comes to tax efficiency, says Murphy of Murphy Capital Advisors. If individual ETFs within a packaged product finish the year at a loss, the fund-of-fund structure prevents him from doing tax loss harvesting. "You are actually at a disadvantage," he says.
The other half of the question-whether ETFs are a better or worse tool than active mutual funds-has an easy answer: They are, without question, better.