How To Avoid The Worst Style ETFs 2Q22

Question: Why are there so many ETFs?

Answer: ETF issuance is profitable, so Wall Street keeps cranking out more products to sell.

The large number of ETFs has little to do with serving your best interests as an investor. I leverage reliable & proprietary fundamental data to identify three red flags you can use to avoid the worst ETFs:

1. Inadequate Liquidity

This issue is the easiest issue to avoid, and my 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. Small ETFs also generally have lower trading volume, which translates to higher trading costs via larger bid-ask spreads.

2. High Fees

ETFs should be cheap, but not all of them are. The first step is to benchmark what cheap means.

To ensure you are paying at or below average fees, invest only in ETFs with total annual costs below 0.48% – the average total annual cost of the 701 U.S. equity Style ETFs my firm covers. The weighted average is lower at 0.14%, which highlights how investors tend to put their money in ETFs with low fees.

Figure 1 shows Emles Alpha Opportunities ETF (EOPS) is the most expensive style ETF and JPMorgan BetaBuilders U.S. Equity ETF BBUS
is the least expensive. Absolute Shares WBI WBIL
, WBIG
, WBIF
provides three of the most expensive ETFs while JPMorgan BetaBuilders U.S. Equity ETF (BBUS) is the cheapest.

Figure 1: 5 Most and Least Expensive Style ETFs

Investors need not pay high fees for quality holdings. State Street SPDR Portfolio S&P 1500 Composite Stock Market ETF SPTM
is one of the best ranked style ETFs in Figure 1. SPTM’s neutral Portfolio Management rating and 0.03% total annual cost earn it an attractive rating. Roundhill Acquirers Deep Value ETF (DEEP) is the best ranked style ETF overall. DEEP’s very attractive Portfolio Management rating and 0.89% total annual cost earn it a very attractive rating.

On the other hand, no matter how cheap an ETF, if it holds bad stocks, its performance will be bad. The quality of an ETF’s holdings matters more than its price.

3. Poor Holdings

Avoiding poor holdings is by far the hardest part of avoiding bad ETFs, but it is also the most important because an ETFs performance is determined more by its holdings than its costs. Figure 2 shows the ETFs within each style with the worst portfolio management ratings, a function of the fund’s holdings.

Figure 2: Style ETFs with the Worst Holdings

Nuveen (NUMG, NSCS) appears more often than any other provider in Figure 2, which means that it offers the most ETFs with the worst holdings.

Roundhill MEME ETF (MEME) is the worst rated ETF in Figure 2 and earns a very unattractive rating. Renaissance IPO ETF (IPO), Nuveen Small Cap Select ETF (NSCS), Hoya Capital High Dividend Yield ETF (RIET), and Invesco Real Assets ESG ETF (IVRA) also earn a very unattractive predictive overall rating, which means not only do they hold poor stocks, they also charge high total annual costs.

The Danger Within

Buying an ETF without analyzing its holdings is like buying a stock without analyzing its business model 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 HOLDINGS – FEES = PERFORMANCE OF ETF

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

Source: https://www.forbes.com/sites/greatspeculations/2022/06/15/how-to-avoid-the-worst-style-etfs-2q22/