How To Avoid the Worst Sector ETFs

8474532085_6d010ee8d0_z
Share with your friends










Submit

Why are there so many ETFs? The answer is: because ETF providers are making lots of money selling them. The number of ETFs has little to do with serving your’ best interests. Below are three red flags you can use to avoid the worst ETFs:

  1. Inadequate Liquidity

This is the easiest issue to avoid, and our advice is simple: Avoid all ETFs with less than $100 million in assets. Low levels of liquidity can lead to a discrepancy between the price of the ETF and the underlying value of the securities it holds. In addition, low asset levels tend to mean lower volume in the ETF and large bid-ask spreads.

  1. High Fees

ETFs should be cheap, but not all of them are. The first step here is to know what is cheap and expensive.

To ensure you are paying at or below average fees, invest only in ETFs with an expense ratio below 0.53%, which is the average expense ratio of the 188 U.S. equity ETFs we cover.

Figure 1 shows the most and least expensive sector ETFs in the U.S. equity universe based on total annual costs. ProShares provides three of the most expensive ETFs while Vanguard and Fidelity ETFs are among the cheapest.

Figure 1: 5 Least and Most Expensive Sector ETFs

Untitled

Sources: New Constructs, LLC and company filings

However, investors need not pay high fees for good holdings. State Street SPDR Consumer Staples Select Sector Fund (XLP) is our highest-rated sector ETF and earns our Very Attractive rating. It also has low total annual costs of only 0.17%.

On the other hand, Schwab U.S. REIT ETF (SCHH) holds poor stocks and no matter how cheap a mutual fund, if it holds bad stocks, its performance will be bad. The quality of a mutual fund’s holdings matters more than its price.

  1. Poor Holdings

Avoiding poor holdings is by far the hardest, but it is also the most important because an ETF’s performance is determined more by its holdings than its costs. Figure 2 shows the ETFs within each sector with the worst holdings or portfolio management ratings.

Figure 2: Sector ETFs with the Worst Holdings

Untitled

Sources: New Constructs, LLC and company filings

PowerShares appears more often than any other providers in Figure 2, which means that they offer the most ETFs with the worst holdings.

Our overall ratings on ETFs are based primarily on our stock ratings of their holdings. New Constructs covers over 3000 stocks and is known for the due diligence we do on each stock we cover.

The Danger Within

Buying an ETF without analyzing its holdings is like buying a stock without analyzing its business and finances. Put another way, research on ETF holdings is necessary due diligence because an ETF’s performance is only as good as its holdings’ performance.

PERFORMANCE OF ETF’s HOLDINGs = PERFORMANCE OF ETF

Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, sector, or theme.

Photo Credit: Epsos.de (Flickr)

 

Leave A Response

* Denotes Required Field