With an ever-growing list of similar-sounding ETFs to choose from, finding the best is an increasingly difficult task. How can investors change the game to shift the odds in their favor?
Don’t Trust ETF Labels
There are at least 168 different All Cap Blend ETFs and at least 725 ETFs across twelve styles. Do investors need 60+ choices on average per style? How different can the ETFs be?
Those 168 All Cap Blend ETFs are very different from each other. With anywhere from 21 to 3,997 holdings, many of these All Cap Blend ETFs have drastically different portfolios with differing risk profiles and performance outlooks.
The same is true for the ETFs in any other style, as each offers a very different mix of good and bad stocks. Large Cap Value ranks first for stock selection. Small Cap Growth ranks last. Details on the Best & Worst ETFs in each style are here.
Avoiding Analysis Paralysis
We think the large number of style ETFs hurts investors more than it helps. Manually conducting a deep analysis for every ETF is simply not a realistic option, exposing investors to insufficient analysis and missing profitable opportunities. Analyzing ETFs, with the proper diligence, is far more difficult than analyzing stocks because it means analyzing all the stocks within each ETF. As stated above, there can be as many as 3,997 stocks or more for one ETF.
Anyone focused on fulfilling the fiduciary duty of care recognizes that analyzing the holdings of an ETF is critical to finding the best ETF. More reliable & proprietary fundamental data, proven in The Journal of Financial Economics, drives our research and analysis of ETF holdings and provides investors with a new source of alpha. Figure 1 shows our top-rated ETF for each style.
Figure 1: The Best ETF in Each Style
* Best ETFs excludes ETFs with Total Net Assets (TNA) under $100 million due to inadequate liquidity
Sources: New Constructs, LLC and company filings
Amongst the ETFs in Figure 1, Direxion Daily Homebuilders and Supplies Bull 3X Shares (NAIL) ranks first overall, Alpha Architect U.S. Quantitative Value ETF (QVAL) ranks second, and Cambria ETF Trust: Cambria Value (VAMO) and Momentum ETF ranks third. Invesco S&P MidCap Momentum ETF (XMMO) ranks last.
How to Avoid “The Danger Within”
Why do you need to know the holdings of ETFs before you buy?
You need to be sure you do not buy an ETF that might blow up. Buying an ETF without analyzing its holdings is like buying a stock without analyzing its business and finances. No matter how cheap, if it holds bad stocks, the ETF’s performance will be bad. Don’t just take my word for it, see what Barron’s says on this matter.
PERFORMANCE OF FUND’S HOLDINGS – FEES = PERFORMANCE OF FUND
Analyzing each holding within funds is no small task. Our Robo-Analyst technology enables us to perform this diligence with scale and provide the research needed to fulfill the fiduciary duty of care. More of the biggest names in the financial industry (see At BlackRock, Machines Are Rising Over Managers to Pick Stocks) are now embracing technology to leverage machines in the investment research process. Technology may be the only solution to the dual mandate for research: cut costs and fulfill the fiduciary duty of care. Investors, clients, advisors and analysts deserve the latest in technology to get the diligence required to make prudent investment decisions.
If Only Investors Could Find Funds Rated by Their Holdings
Our ETF ratings leverage our stock coverage. We rate ETFs based on the aggregated ratings of the stocks each ETF holds.
Direxion Daily Homebuilders and Supplies Bull 3X Shares is not only the top-rated All Cap Blend ETF, but is also the overall top-ranked style ETF out of the 725 style ETFs that we cover.
The worst ETF in Figure 1 is Invesco S&P MidCap Momentum ETF, which still gets a Very Attractive rating.
This article was originally published on February 9, 2023.
Disclosure: David Trainer, Kyle Guske II, and Italo Mendonca receive no compensation to write about any specific stock, style, or theme.
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 Harvard Business School features the powerful impact of our research automation technology in the case New Constructs: Disrupting Fundamental Analysis with Robo-Analysts.
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