The rapid proliferation of the exchange-traded fund (
) industry has been a boon for investors.
Many folks now simply focus on a key sector or trend, and buy
the most suitable ETF to hit their target. For these folks, the
time and energy of individual stock research just isn't worth it.
Yet the process of picking the right ETF can be downright
Let's say you want to own an ETF that focuses on industrial
companies. Do you choose the
SPDR Industrial Select Sector ETF (NYSE:
Vanguard Industrials Index ETF (NYSE:
iShares Dow Jones U.S. Industrial Sector Index ETF (NYSE:
? Before you answer that question, know that there are also more
than a dozen other industrial ETFs, with a niche focus on China,
multinationals, small caps... the list goes on.
Frankly, we may have reached a point of too many ETFs, and
some funds will simply wither away from a lack of interest.
According to XTF.com, investors can now
choose from more than 1,600 ETFs
that collectively control more than $150 billion in assets. In
just the month of June, 24 new ETFs were launched. It's getting
hard to keep score.
Many new ETFs are falling under the category of "smart beta,"
which I discussed a few months ago
. These funds tend to be pricier than traditional passive ETFs,
which have less portfolio turnover and, typically, much lower
To help you choose the best ETFs, it helps to assess the
companies behind these funds, known in the industry as ETF
sponsors. Many of them pursue distinct strategies, and may or may
not dovetail with your investing style. First, you should know
about the big three:
State Street's (NYSE:
SPDRs funds, and the Vanguard funds.
All of these firms aim for big market niches and can often
gather $1 billion or more in assets under management (AUM) for
each fund they sponsor. That helps them to establish rock-bottom
expense ratios, and their high trading volumes tend to lead to
small bid/ask spreads. As a result, many investors use these
funds as short-term tactical trading vehicles. Their transaction
costs are so low that they can be bought and sold with frequency
-- if you have a strong sense that a certain investment theme
will play out in the next few months.
Look for more action on the low-cost front: Fidelity and
are making a big push into low-cost ETFs as well.
The overwhelming size of these ETF behemoths means that
smaller rivals must scramble for niches that are not covered by
others. Take WisdomTree as an example. That firm offers a wide
range of funds, but may be best known for its dividend and
earnings growth-focused funds, which target China, small caps and
many other regions and asset classes. According to
, WisdomTree's funds have an average expense ratio of 0.50%,
which makes their funds best-suited for investors that have a
longer time horizon with their investments.
I am especially intrigued by the ETF industry's smaller
players. Their funds aren't always a great choice as they can
carry high expense ratios and often struggle to gather a large
base of assets to manage. But such funds exploit creative
investing themes, and can deliver solid returns. For example, the
PowerShares Buyback Achievers ETF (NYSE:
AdvisorShares TrimTabs Float Shrink ETF (NYSE:
were quick to spot the share buyback phenomenon and capitalized
on their popularity while the big ETF players were caught
napping. The fact that such funds have done well offsets the pain
of relatively high expense ratios.
Moving further downstream is one of my favorite fund firms:
This firm has committed its energy to developing many
country-specific ETFs, from Scandinavia to Africa to the Far
East, greatly enhancing access to these markets and regions for
U.S. investors. One of my favorite ETFs -- in theory -- is the
Global X FTSE Andean 40 ETF (NYSE:
, which focuses on the
dynamic economic growth in the Western flank of
. I say "in theory" because this fund has less than $10 million
in AUM and very low trading volumes. It's simply too small to
recommend. Instead, investors may as well focus on a bigger
regional fund such as iShares MSCI Chile Capped (
), which has more than $300 million in AUM.
I'm also keeping an eye on a new fund firm, KraneShares, which
has launched three new China-focused funds over the past year.
For example, its
KraneShares CSI China Internet ETF (Nasdaq:
, which focuses on Chinese growth stocks, is up an impressive 35%
since launching last August. According to its fund marketing
materials, the company works with an index provider that builds
and rebalances the portfolio. The index aims to weed out the
riffraff of dubious Chinese companies that have made that country
a no-go destination for U.S. investors.
Risks to Consider:
Any ETFs that fail to develop a meaningful base of AUM after
a few years is at risk of being closed. And simply liquidating
stakes in a portfolio can cause downward pressure on the
underlying price of those holdings that are being sold.
Action to Take -->
The best approach to ETFs: Become familiar with 30 or 40 funds
that meet your criteria in various investing climates -- and
forget about the other 1,600. That way, you can selectively move
in and out of those funds you know well as valuation, growth
rates or macroeconomic issues change from year to year.
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