How To Find The Best Sector ETFs 3Q22

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 78 different Technology ETFs and at least 297 ETFs across eleven sectors. Do investors need 11+ choices on average per sector? How different can the ETFs be?

Those 78 Technology ETFs are very different from each other. With anywhere from 22 to 564 holdings, many of these Technology ETFs have drastically different portfolios with differing risk profiles and performance outlooks.

The same is true for the ETFs in any other sector, as each offers a very different mix of good and bad stocks. Financials ranks first for stock selection. Real Estate ranks last.

Avoiding Analysis Paralysis

I think the large number of sector 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 564 stocks or more for one ETF.

Figure 1 shows the top-rated ETF for each sector.

Figure 1: The Best ETF in Each Sector

* Best ETFs exclude ETFs with TNAs less than $100 million for inadequate liquidity

Amongst the ETFs in Figure 1, First Trust Materials AlphaDEX Fund FXZ
ranks first overall, State Street SPDR S&P Homebuilders ETF XHB
ranks second, and Davis Select Financial ETF DFNL
ranks third. First Trust Utilities AlphaDEX Fund FXU
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.

PERFORMANCE OF FUND’S HOLDINGS = PERFORMANCE OF FUND

If Only Investors Could Find Funds Rated by Their Holdings

First Trust Materials AlphaDEX Fund (FXZ) is not only the top-rated Basic Materials ETF but is also the overall top-ranked sector ETF out of the 297 sector ETFs that my firm covers.

The worst ETF in Figure 1 is First Trust Utilities AlphaDEX Fund (FXU), which gets an Unattractive rating. One would think ETF providers could do better for this sector.

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