Beware Of ETF Easy-Button Selections

January 30, 2019

Many equity ETFs declined in 2018 as the global equity markets sold off, only to bounce back in January amid renewed optimism.

While many investors focus on ETF selection based on a review of the expense ratio, index tracking success or past performance, these approaches fail to account for the fact that most funds are constructed differently from their peers, and performance success can be fleeting. This will be a key topic that CFRA Research intends to highlight on stage at the upcoming Inside ETFs conference in early February.

In an “ETFs 101: Facts & Fiction” session kicking off the Inside ETF conference’s ETF University & Advisor Accelerator track on Sunday, Feb. 10, CFRA will be presenting numerous case studies that highlight the importance of looking inside an ETF before making an investment decision. While we hope to see you all in Florida, we wanted to share some of our research in advance.

Easy Not Always Best

Like your mother always told you, the easiest choice is not always the best choice. Thanks, Mom!

With a growing number of ETFs launching, and brokerage platforms creating custom screens, it’s easy to buy the cheapest, best-performing or commission-free ETFs.

Yet, the iShares Core S&P 500 ETF (IVV), the SPDR S&P 500 Trust (SPY) and the Vanguard S&P 500 (VOO) are rare examples where taking a regular look under the ETF hood is unnecessary. Indeed, most investment style, factor and thematic ETFs follow a unique index with a distinct rule book for implementation. As such, advisors and investors need to ask more questions about the ETF’s approach before deciding to put money to work.

Value Stocks Not Identical 

The iShares Russell 1000 Value ETF (IWD) and the Vanguard Value ETF (VTV) are two of the many large-cap value-oriented ETFs that were popular in the second half of 2018. VTV is the cheaper of the duo, offering a 0.15% savings for investors. This ETF declined just 5.4% in 2018, while IWD fell 300 basis points further, highlighting that what’s inside mattered more than fee differential.

 

  IWD VTV
2018 -8.40% -5.40%
YTD 2019 6.20% 5.80%

 

From a sector perspective, CFRA finds more health care exposure for VTV (18% of assets) than IWD (16%), and less energy exposure (7% vs. 9%). Yet year-to-date through Jan. 25, the 6.2% gain for IWD, stronger than VTV’s 5.8% return, is a reminder that simply choosing the better performer or the cheaper fund comes with risks.

Is The Trend Really Your Friend?

The First Trust Dorsey Wright Focus 5 ETF (FV) and the iShares Edge MSCI U.S.A. Momentum Factor ETF (MTUM) both incorporate relative strength analysis that is determined to spot winners and presume they can continue to run.

Such an approach was popular in the first half of 2018. Despite a shift in investor sentiment later in the year, MTUM’s 1.7% decline for all of 2018 was narrower than the 4.5% loss for IVV. In contrast, FV’s 8.3% was significantly worse. Yet the 11% gain for the more expensive FV thus far in 2019 was stronger than IVV’s 6.3% and more than double the 4.8% for MTUM.

 

  FV MTUM
2018 -8.30% -1.70%
YTD 2019 11% 4.80%

 

FV holds five First Trust ETFs, two of which are health-care-focused. FV’s combined 39% of assets in this sector was much larger than MTUM’s (25% of assets) but blocked exposure to most other sectors. For example, MTUM held an 8% weighting in stocks from the consumer staples sector and 7% in industrials, while FV had no such exposure.

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