Are Commission-Free Sector ETFs Really The Better Choice?
Summary Fidelity offers nine S&P Sector ETFs commission-free to its clients. The SPDR Select Sector funds have a long history and are widely used in various sector-switching strategies. How do the relative performances of these two sets of funds compare if we consider them for the short intervals that are typically used in such strategies? As I described previously ( here ), I maintain a dual-momentum S&P sector-switching portfolio which I rebalance every 30 days. To avoid commissions, I use Fidelity’s S&P Sector ETFs. The alternative, and the basis for most published sector-switching strategies would be SPDR’s long-established series of S&P Sector Select ETFs. The SPDR funds have been in existence since 1998; Fidelity’s offerings are just over two years old. Using the two-years data on the Fidelity funds I compared their performance with the SPDR funds. In doing so, I looked at intervals of 1, 3, 6, 12 and 24 months plus YTD. The results were informative but didn’t really give a satisfactory answer to my question, which was: Is the savings on commissions worthwhile, or might the SPDR funds performance be strong enough to wipe out the commission-free advantage of the Fidelity funds? The reason that exercise was inadequate to answer the question was that I used a single, fixed end-point. What is needed is the full history for the full period. If the funds are traded every 30 days (the minimum to qualify for the free trades), the funds’ relative performances to date is not the most relevant metric. Rather, it’s their performance over rolling 30-day periods for the entire history. I should note here that the actual intervals between trades vary from 30 to as many as 33 calendar days depending on when non-trading weekends and holidays relative to the 30-day minimum holding period. For the purposes of the strategy there’s a $48 fixed-cost for commissions on trading three funds every 30-days if using the SPDR funds. That’s $8/trade for each for three round trips. Funds that have commission costs associated with them would, therefore have to beat the commission-free funds by that $48 a month to justify foregoing the commission free funds. The $48 is a fixed cost regardless of the size of the trades, so the margin of outperformance required will depend on the size of the total portfolio. I’ll use three examples as I proceed. A $10,000 portfolio would need to beat by 0.48 percentage points on average to break even. For a $50K portfolio it would only need to beat by 0.096 points; for $100K, it is a near-trivial 0.048 points. The list of funds I examined is: Fidelity MSCI Consumer Discretionary Index ETF (NYSEARCA: FDIS ) Fidelity MSCI Consumer Staples Index ETF (NYSEARCA: FSTA ) Fidelity MSCI Energy Index ETF (NYSEARCA: FENY ) Fidelity MSCI Financials Index ETF (NYSEARCA: FNCL ) Fidelity MSCI Health Care Index ETF (NYSEARCA: FHLC ) Fidelity MSCI Industrials Index ETF (NYSEARCA: FIDU ) Fidelity MSCI Materials Index ETF (NYSEARCA: FMAT ) Fidelity MSCI Information Technology Index ETF (NYSEARCA: FTEC ) Fidelity MSCI Utilities Index ETF (NYSEARCA: FUTY ) Consumer Discretionary Select Sector SPDR ETF (NYSEARCA: XLY ) Consumer Staples Select Sector SPDR ETF (NYSEARCA: XLP ) Energy Select Sector SPDR ETF (NYSEARCA: XLE ) Financials Select Sector SPDR ETF (NYSEARCA: XLF ) Health Care Select Sector SPDR ETF (NYSEARCA: XLV ) Industrials Select Sector SPDR ETF (NYSEARCA: XLI ) Materials Select Sector SPDR ETF (NYSEARCA: XLB ) Technology Select Sector SPDR ETF (NYSEARCA: XLK ) Utilities Select Sector SPDR ETF (NYSEARCA: XLU ) It’s important to note that these are not strictly comparable in two cases. The Fidelity information technology ETF does not include telecoms; the SPDR information ETF does. SPDR also has a separate financial services fund which has no counterpart in Fidelity’s lineup, so the financial funds take somewhat differing approaches to the sector. My approach to this was to download the full data sets from Yahoo.finance for the Fidelity funds and for the SPDR funds for the same dates (for any interested readers, I use Samir Khan’s Multiple Stock Quote Downloader for Excel to do this efficiently, and highly recommend it.). I computed rolling 30-day returns using adjusted close data to account for dividends. I then plotted the differences between each SPDR fund and its Fidelity counterpart. Results The charts of the difference between the Sector Select SPDR ETF and the Fidelity MSCI Sector Index ETF follow. (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) For these charts, positions above the zero line represent outperformance by the SPDR fund and those below the zero line show outperformance by the Fidelity fund for each of the rolling 30-day period from 11 Dec 2013 through 9 Nov 2015(n=482). The +0.5ppts line is a relevant marker because it’s the break-even point for commission costs on the $10K portfolio. In the next chart we can see that with two exceptions — health care and the poorly matched technology funds — the SPDR funds consistently have greater numbers of higher performing 30-day intervals. (click to enlarge) On a level playing field the choice would seem to favor the SPDR ETFs. But what about the original question? Now that we know the SPDR funds outperform in seven of the nine cases, we need to know if they outperform by sufficient margins and with sufficient frequency to overcome their commission costs. In this table, I list the percent of 30-day rolling returns where the SPDR ETFs met the minimum difference excess return required for break-even for each of three portfolio sizes, $10K, $50K and $100K. For the $10,000 portfolio it’s not even close. The commission costs would have been covered by superior returns from the SPDRs only 15.6% of the time on average. For much larger portfolios, $50 or $100K, it’s a near-wash, but even there the SPDRs fall short of clearing the break-even bar, albeit by a trivial amount. Summary S&P sector funds fill a niche in the market for a diverse range of switching strategies. Many of these involve short-term hold times and thirty days is not an uncommon choice. For traders who seek to save the commission costs associated with those frequent trades, the Fidelity offerings may be the only game in town. (Merrill Edge does offer 30 to 100 free trades a month for stocks or ETFs but requires a minimum of $25,000 in a cash account at either Merrill or Bank of America. For some, this can be an ideal choice.) I wanted to know if the Fidelity alternatives performed as well as the SPDRs or if the commissions (which are, after all, modest) might be a small price for getting better performance. I felt it was useful to put the results here because I’m sure I’m not alone in looking to the Fidelity sector funds as the cheaper alternative to the SPDR Select Sector ETFs. Results are interesting. The SPDR funds do outperform the Fidelity funds in all but two cases. One of these, Technology, is not a fully parallel comparison, so we can discount it. The other, Health Care, is a clear win for Fidelity unless I’ve missed nuances in the way the funds are structured. However, the differences are small enough to not justify moving to the SPDR funds. And, even if they were enough to push the over the break-even point, for my purposes I would opt for the Fidelity Health Care and InfoTech funds anyway. Indeed, I may change my pool to include the SPDR funds in the Consumer Discretionary, Energy and Industrial sectors where they are providing stronger returns. Realize, too, that I’ve treated the returns as a binary condition; they either make a cut or don’t. I’ve not considered the extent of outperformance, which can, of course, make a bit difference. A strictly qualitative look seems to indicate that the results are close enough that the analysis may not be worth the effort it will take, but I will spend some time thinking about how to go about doing it. Brokers are competing for our investing dollars. One front on these competitive battles is offering commission-free ETFs. These can be a boon to many of us who regularly invest modest amounts. I am much more willing to attempt to implement momentum strategies having a range of commission-free options available. At this time I have active three such strategies, all based on 30-day intervals using Fidelity’s cost-free ETFs (and all in IRA accounts, so there are no tax-consequences from the frequent trading). I’ve been wondering for some time if the commission-free funds were truly competitive. Superficial looks led me to the conclusion that they may not be my first choice for a buy and hold position, but for frequent trading commission-free, they are more than adequate. I’m satisfied that this casually validated finding is borne out by this more detailed look in the case of the sector funds.