What it means
A normal exchange-traded fund (ETF) holds a basket of securities and trades on a stock exchange like a share. An ETF of ETFs, sometimes called a fund of funds, holds units of other ETFs instead.
For example, one fund might hold an equity ETF, a bond ETF and a property ETF in set proportions. The main appeal is simplicity.
An investor who wants a balanced portfolio can buy one fund, and the manager chooses the underlying ETFs and rebalances them. This can suit people who do not want to build and maintain a portfolio themselves.
Fees need careful attention. The investor pays the fund's own expense ratio and also bears the expenses of the underlying ETFs, which reduce returns inside the fund.
Some providers waive their own fee or hold only their own funds, so the total cost varies. There can be other drawbacks.
Holdings may overlap, with several underlying ETFs owning the same shares, and the structure can make it harder to see exactly what is owned. Tax treatment and trading costs may also be more complex than for a simple ETF.
Investors should read the fund's factsheet to see the underlying funds, the total cost and the strategy. Comparing the total cost with building a similar mix yourself shows whether the convenience is worth the price.
For many, a low-cost version with sensible allocations is a good simple option.
In practice
Real-world examples.
Example
A new investor with $10,000 wants a diversified portfolio but does not know how to choose funds. She buys a single ETF of ETFs holding global shares and bonds. The fund automatically rebalances as markets move.
Example
A financial adviser uses an ETF of ETFs for small client accounts. It saves time compared with managing individual funds for each client. Larger clients receive tailored portfolios built directly.
Example
A saver notices that her ETF of ETFs charges 0.45% in total, compared with about 0.15% for a similar mix of simple index funds. She switches to a cheaper option. Over twenty years, the saving could be substantial.
Formula
Calculation
Total expense ratio = Fund's own fee + Weighted average fee of underlying ETFs
Worked example: An ETF of ETFs charges its own fee of 0.10% a year. The underlying ETFs it holds have an average fee of 0.20%. An investor holds $50,000.
Total expense ratio = 0.10% + 0.20% = 0.30%
Annual cost = $50,000 x 0.30% = $150
Buying the underlying ETFs directly at 0.20% would cost $50,000 x 0.20% = $100 a year, so the convenience costs $50 a year extra.Case study
Seen in the real world.
Bridgeway Wealth is an illustrative, fictional adviser with many small clients who wanted diversified portfolios but had balances under $20,000. Building separate portfolios for each was too time-consuming. Most clients had little investment experience and wanted a simple solution. Fees on small accounts had been a concern for the firm's compliance team.
The firm chose an ETF of ETFs holding a mix of equities, bonds and property funds. Clients paid a total cost of 0.35% a year, slightly higher than building the portfolios directly, but the firm saved hours of administration. The firm also reviewed the fund each year to confirm that it still suited clients.
In this illustrative story, a client later discovered that two of the underlying ETFs held many of the same large technology shares, giving more exposure than expected. The adviser explained the overlap and adjusted the allocation. The case shows the value of looking through the wrapper to the true holdings. She was reassured that the fund still met her goals, and she decided to keep it.
Watch out
Common mistakes.
- Ignoring the second layer of fees, when the total cost includes the underlying ETFs. Even a small difference in fees compounds over many years. The factsheet often shows only the top-level fee, so ask for the underlying costs too.
- Assuming the fund is automatically diversified, when underlying funds can overlap heavily. Reading the top holdings of each underlying fund reveals the overlap.
- Buying without reading the holdings, when the actual mix may not match the investor's goals. The factsheet lists the allocation and should match the investor's time horizon.
Questions
People also ask.
What is the difference between an ETF of ETFs and a normal ETF?
A normal ETF holds shares or bonds directly, while an ETF of ETFs holds units of other ETFs. It is a wrapper around other funds, not a direct holding of companies.
Why would someone choose one?
It offers a ready-made, rebalanced mix in a single purchase, which saves time and effort. Some versions adjust the mix as the investor approaches retirement. This suits people who prefer to make a single decision and let the manager handle the rest.
How can I check the total cost?
Look for the total expense ratio on the factsheet and add any underlying fund fees if they are shown separately. If the figure is unclear, ask the provider to confirm it in writing.
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