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How To Find The Best Style ETFs

February 11th, 2014

etfs etfsDavid Trainer: Finding the best ETFs is an increasingly difficult task in a world with so many to choose from.

You Cannot Trust ETF Labels

There are at least 49 different Large Cap Value ETFs and at least 237 ETFs across all styles. Do investors need that many choices? How different can the ETFs be?

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Those 49 Large Cap Value ETFs are very different. With anywhere from 18 to 1,412 holdings, many of these Large Cap Value ETFs have drastically different portfolios, creating drastically different investment implications.

The same is true for the ETFs in any other Style, as each offers a very different mix of good and bad stocks. Some styles have lots of good stocks and offer quality funds. The opposite is true for some styles, while others lie in between these extremes with a fair mix of good and bad stocks. For example, the Large Cap Value style, per my 1Q Style Rankings Report, ranks third out of 10 styles when it comes to providing investors with quality ETFs.  Large Cap Blend ranks first. Small Cap Value ranks last. Details on the Best & Worst ETFs in each Style are here.

The bottom line is: ETF labels do not tell you the kind of stocks you are getting in any given ETF.

Paralysis By Analysis

I firmly believe ETFs for a given style should not all be that different. I think the large number of Large Cap Value (or any other) style of ETFs hurts investors more than it helps because too many options can be paralyzing. It is simply not possible for the majority of investors to properly assess the quality of so many ETFs. Analyzing ETFs, done with the proper diligence, is far more difficult than analyzing stocks because it means analyzing all the stocks within each ETF. As stated above, that can be as many as 1,412 stocks, and sometimes even more, for one ETF.

Any investor worth his salt recognizes that analyzing the holdings of an ETF is critical to finding the best ETF.

Figure 1: Best Style ETFs

Screen shot 2014-02-11 at 9.09.50 AM

Sources:   New Constructs, LLC and company filings

The Danger Within

Why do investors need to know the holdings of ETFs before they buy? They need to know to be sure they do not buy a fund that might blow up. Buying a fund without analyzing its holdings is like buying a stock without analyzing its business and finances. As Barron’s says, investors should know the Danger Within. No matter how cheap, if it holds bad stocks, the ETF’s performance will be bad.

PERFORMANCE OF FUND’S HOLDINGS = PERFORMANCE OF FUND

Finding the Style ETFs with the Best Holdings

Figure 1 shows my top rated ETF for each Style. Importantly, my ratings on ETFs are based primarily on my stock ratings of their holdings. My firm covers over 3,000 stocks and is known for the due diligence we do for each stock we cover. Accordingly, our coverage of ETFs leverages the diligence we do on each stock by rating ETFs based on the aggregated ratings of the stocks each ETF holds.

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