These Overrated ETFs Deserve to See Assets Shrink

Sam Worthington in "Avatar." Photograph: 20th Century Fox/Everett Collection Close

Sam Worthington in "Avatar." Photograph: 20th Century Fox/Everett Collection

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Sam Worthington in "Avatar." Photograph: 20th Century Fox/Everett Collection

Like New Year's Eve, "American Idol" and the movie "Avatar," some ETFs are grossly overrated.

There are 80 ETFs in the U.S. with more than $5 billion in assets. The vast majority of them earned their assets by providing good exposure to different markets at a reasonable cost. A few behemoths, though, are seriously flawed or needlessly expensive. They stay as big as they are because they were first to market and, thanks to all those assets, are easy to trade in and out of at a good price.

If the same ETFs were launched today, they would probably flop. When it comes to the mega-ETFs described below, long-term investors would do better looking elsewhere.

  • SPDR Dow Jones Industrial Average ETF Trust (DIA)

This was the twentieth ETF ever launched, back in 1998. It has $11.5 billion in assets and does a great job tracking its index for a low annual fee of 0.17 percent. The problem: The Dow Jones Industrial Average is the index equivalent of a rotary phone. The index was launched in 1896, when Grover Cleveland was president, and before aspirin existed. It tracks a narrow slice of the market -- 30 stocks -- despite the fact that the media quote it every day.

Another flaw is that the index is price-weighted. That means the stocks trading at the highest prices get the highest weightings in the ETF. Visa Inc. (V) is the current largest holding, with an 8 percent weighting, simply because it trades at $213 a share. It's followed by IBM -- because IBM trades at $194. Microsoft (MSFT) only gets a 1 percent weighting because it trades at $43. If that seems silly, it is. Investors are better served with a big large-capitalization or broad market ETF that uses market-cap weighting.

Alternatives: Vanguard S&P 500 ETF (VOO) for large-cap equity exposure, or Schwab U.S. Broad Market ETF (SCHB) for broad market exposure

  • iShares MSCI Emerging Markets ETF (EEM)

This giant, with $43 billion in assets, needs no introduction. The problem here isn’t so much its investment universe or the weighting of holdings. It’s cost. EEM charges 0.67 percent of assets annually. That's 450 percent more expensive than equivalent products on the market charging 0.15 percent. Imagine buying a car for $67,000 that you could get for $15,000. That high expense ratio wreaks havoc on the ETF's ability to track its index, which is why EEM underperformed its benchmark by 7 percentage points over the past five years and 19 percentage points over the past 10 years.

EEM is beloved by traders who worship its liquidity. For smaller, long-term investors, the high expense ratio matters much more.

Alternatives: iShares Core MSCI Emerging Markets ETF (IEMG), Vanguard FTSE Emerging Markets ETF (VWO)

  • iShares China Large-Cap ETF (FXI)

FXI's flaws make up a double whammy. First, while it's the largest China ETF, with $5.3 billion in assets, it's also the narrowest. It tracks 25 stocks, and has a disproportionate 55 percent allocation to the financial sector. It also doesn’t include U.S.-listed Chinese companies, which tend to be more innovative tech companies. And then there's the 0.74 percent expense ratio -- on the high side for a China ETF. It’s just not worth it for investors.

Alternatives: SPDR S&P China ETF (GXC), iShares MSCI China ETF (MCHI), db X-trackers Harvest MSCI All China Equity Fund (CN), which includes China A-shares

More stories from Eric Balchunas:

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Eric Balchunas is an exchange-traded-fund analyst at Bloomberg. More ETF data is available here, and weekly ETF podcasts can be found here.

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