David 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 45 different Financials ETFs and at least 182 ETFs across all sectors. Do investors need that many choices? How different can the ETFs be?
Those 45 Financials ETFs are very different. With anywhere from 21 to 550 holdings, many of these Financials ETFs have drastically different portfolios, creating drastically different investment implications.
The same is true for the ETFs in any other sector, as each offers a very different mix of good and bad stocks. Some sectors have lots of good stocks and offer quality funds. The opposite is true for some sectors, while others lie in between these extremes with a fair mix of good and bad stocks. For example, the Financials sector, per my 1Q Sector Rankings Report, ranks ninth out of 10 sectors when it comes to providing investors with quality ETFs. Consumer Staples ranks first. Utilities ranks last. Details on the Best & Worst ETFs in each sector 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 sector should not all be that different. I think the large number of Financials (or any other) sector 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 550 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 Sector ETFs
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 Sector ETFs with the Best Holdings
Figure 1 shows my top rated ETF for each sector. Importantly, my ratings on ETFs are based primarily on my stock ratings of their holdings. My firm covers over 3000 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.