The performance of an ETF is driven by the performance of its holdings. This observation should be inherently obvious, but it seems to be controversial among the investing community. Proponents of “passive” investing tell investors to ignore holdings and focus solely on past performance, costs, and sector/style diversification.

The proliferation of stock indices – there are now 3.3 million indices compared to just 43 thousand stocks globally – makes the passive view untenable. To whatever piece of the market you want exposure, there are dozens of indices with that label, all with different strategies and compositions. Any investor that buys a fund based solely on the label puts themselves at risk, and any advisor that recommends an index fund without analyzing the holdings of that fund is not fulfilling their fiduciary Duty of Care.

For years, we have analyzed[1] the holdings of over 7,500 U.S. ETFs and mutual funds daily to identify which fund managers and indices hold the most attractive stocks. We’re excited to see that others in the market increasingly understand the need for this holdings-based diligence, as evidenced by the announcement that Bank of America (BAC) will begin rating ETF’s based on their holdings.

We think this increased appreciation for holdings quality research will make the market more efficient by pushing capital towards funds that hold highly profitable and undervalued stocks.

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