Publish date:

All-ETF Portfolio Wins, at the Cost of Yield

An experiment shows what these products can and can't do.

A reader recently reminded me that about a year ago (June 27, 2006, to be exact), I


a very detailed all-ETF portfolio on my blog. It was an academic exercise to see whether I could use narrow-based ETFs to capture the value of a single-stock portfolio with less volatility and risk. He wanted to know how it had performed. The fast answer is that it appears to have done well, with a total return of 22.46%. (The

S&P 500

is up 20.46% in the same period.)

But I'm less interested in the exact performance than in what the experiment proves.

Before we discuss the results, let's look at the portfolio. To be crystal clear, I don't have this portfolio for anyone. I still believe in (and even prefer) individual stocks, and advocate a mix of individual stocks and ETFs. And honestly, I'd completely forgotten about this academic exercise, so I haven't made any changes to it since I loaded it into Morningstar last June.

The portfolio was built in a manner similar to how I typically build portfolios for clients: I build in exposure to each big sector of the

S&P 500

. Again, I created it to study whether it would be possible to use ETFs instead of individual stocks to isolate some very narrow themes.

I chose funds with an eye to drawing on products from most of the fund companies, but I didn't necessarily use the most popular funds out there. I'm a big believer in exploring second- and third-to-market funds because some of them can turn out to be superior to the first-to-market product in the space.

One very interesting thing about the portfolio's performance is that it resembles the way my client accounts performed over the same period in terms of when it lagged and when it led. This is despite my using very few of these funds in client accounts, which I think makes a compelling argument for top-down portfolio management -- a topic for another day.

In looking at the chart, the returns seem favorable on a risk-adjusted basis -- the all-ETF ride looks a tad smoother than the S&P 500 -- but Morningstar does not have the necessary statistics to corroborate this. According to, the standard deviation for the portfolio is 12.09, which is higher than the S&P 500's 10.06.

Here's the portfolio (to view it on Stockpickr, with the rationale for each choice,

click here):

It lagged last summer off the bottom of the correction and has outperformed modestly since. Notice that during the first-quarter stress test, it outperformed noticeably.

TheStreet Recommends

The big disappointment with this portfolio is the yield. When I first put it together, the yield was only 0.9%. Now, according to Morningstar, it's grown to a still-low 1.32% -- much lower than the S&P 500's yield.

A lack of yield seems to me to be the biggest drawback of using funds (ETFs or otherwise) instead of individual stocks. For example,

iShares Australia

(EWA) - Get iShares MSCI Australia ETF Report

yields 3.94%, which seems like a great yield, but there are several Australian bank stock ADRs that yield close to 5%. Another example would be

PowerShares China

(PGJ) - Get Invesco Golden Dragon China ETF Report

, which has no yield, but the mega-cap names in the fund have yields of 3% and higher.

Since I first assembled this portfolio,


has entered the fray and goes some distance toward rectifying the dividend issue. While sprinkling some of its funds into this sort of mix would increase the yield -- and to be clear, I believe in WisdomTree's products and use a couple in my practice -- there is probably a higher yield to be had by integrating individual stocks into the mix.

The big reason for this academic exercise was to show that, contrary to most of what is said and written about narrow-based products, and as volatile as some of them may be as stand-alone funds, there is a way to use them properly to construct a diversified portfolio.

By going very narrow, subsectors can be overweighted and underweighted, allowing for very precise volatility management. I believe that this portfolio demonstrates that this type of management and strategy is available without taking single-stock risk.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider StateStreet Bank, StateStreet Capital Markets, iShares Global Tech, iShares Defense, PowerShares Semicon, iShares Medical Device, StateStreet Biotech, iShares Consumer, PowerShares Food, PowerShares Leisure, PowerShares E&P, PowerShares China, StateStreet Miners, Vanguard Utilities, Vanguard Telecom and Emerging Markets Telecom to be small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

At the time of publication, Nusbaum held StateStreet Bank, iShares Global Tech, iShares Taiwan, iShares Global Health, iShares Consumer, PowerShares Water, iShares Global Energy, streetTracks Gold Shares and Vanguard Telecom are client holdings, although positions may change at any time.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback;

click here

to send him an email.