A popular argument for using exchange traded funds is that investors receive more bang for their buck because ETFs are generally cheaper than mutual funds. In some cases, however, the bang is being muted because of the way ETF returns are reported.
Many times, returns reported by the ETF providers don't jibe with returns that financial advisers get from the brokerage firms through which they buy ETFs, observers say.
It's a potential problem for advisers trying to explain the benefits of ETFs to their clients, and may have ramifications for the industry's reputation.
"There are many advisers who make an argument that by using ETFs, they're able to save [a percentage point] a year, plus or minus [half a percentage point]," said Tom Lydon, president of Global Trends Investments, a Newport Beach, Calif.-based firm that manages $75 million in assets.
"If that [0.5] to [1.5 percentage] points is lost in a performance analysis fog ... are we losing the value of ETFs?" he asked.
ETF providers said they are aware of the issue.
"It comes up from time to time," said Kevin Feldman, director of global web solutions at Barclays Global Investors of San Francisco.
Discrepancies in returns are due partly to the way brokerage firms handle ETFs, he said.
For example, with ETFs and mutual funds, the performance reported by the product providers incorporates dividend distributions.
This generally doesn't lead to a discrepancy with regard to mutual fund returns, because most mutual fund investors take advantage of their fund's automatic-dividend-reinvestment feature.
But ETFs are a different animal — their dividends must be reinvested by the broker through which the ETF was purchased.
It's a problem because the time at which the broker makes dividend reinvestments may differ from the time at which the asset manager assumes they will be made.
PERFORMANCE DISPARITY
That can lead to differences in performance, said Daniel P. Wiener, the Brooklyn, N.Y.-based editor of The Independent Adviser for Vanguard Investors.
It's one of the reasons he believes there is a difference between the market price returns reported by
The Vanguard Group Inc. of Malvern, Pa., and the market price returns he sees from ETFs held in his Vanguard brokerage account.
The market price return is the return actually earned by ETF investors.
ETF providers also report the net asset value return of ETFs: the total return of an ETF based on its NAV at the beginning and end of the holding period.
Looking at third-quarter year-to-date performance reports for the 37 ETFs that have been in existence for the entire year, Vanguard got the market price return right only on two of them: the Vanguard Total Bond Market ETF (BND) and the Vanguard High Dividend Yield Index ETF (VYM), Mr. Wiener said.
Of the other 35 ETFs, Vanguard's reported performance varied from underreporting by as much as 2.19% on the Vanguard European Stock ETF (VGK) to overreporting by 0.65% on the Vanguard MegaCap 300 Index ETF (MGC), he said.
Mr. Wiener's use of market price, however, may have led to the differences, said Rebecca Cohen, a spokes--woman for Vanguard.
In market price calculations, performance differences appear largely due to how "closing price" is defined, she said.
Vanguard uses the midpoint of the national best bid/ask price as of 4 p.m. to determine closing price.
Mr. Wiener's analysis uses a price based on the last trade of the day, which can take place up to 8 p.m.
"We believe the midpoint is a more relevant measure," Ms. Cohen said.
It's just another example of how complicated ETF pricing can be.
"When it comes to pricing, there are lots of prices out," said Jeff Tjornehoj, a Denver-based analyst with Lipper Inc. of New York. "It's definitely not as transparent and straightforward as mutual funds."
TIMING DISPUTES
Mr. Wiener's analysis doesn't even touch on the issue that probably results in the biggest price discrepancies: when exactly an ETF is purchased, said Dylan Ross, an adviser with hourly-fee-based Swan Financial Planning LLC of East Windsor, N.J.
"Let's say an ETF reported a 2% return for 30 days when the price went from $50 at the open on Day One to $51 at the close of Day 30," he said.
"But Joe the investor bought the ETF at 11 a.m. on Day One at $50.50, so at the close on Day 30, his return is 1%."
ETFs are not like mutual funds, where everyone who gets in on the same day gets the same price, and that makes finding a solution to price discrepancies difficult, if not impossible.
"Until someone comes out with some kind of performance calculation standardization, you will always have some disparity in performance reporting," said Bill Koehler, chief investment officer of ETF Portfolio Solutions Inc., a Leawood, Kan.-based advisory firm with $40 million in assets.
One thing ETF providers could do is maintain accounts at different brokerage firms to determine the returns achieved by investors, Mr. Wiener said.
That, however, is not likely to happen.
ETF providers are adamant that the returns they are providing are accurate.
About the only action advisers can take is to go to the broker and quiz him or her about "assumptions" the broker is making concerning ETF returns, Mr. Feldman said.
E-mail David Hoffman at [email protected].
