In one of my previous articles, I wrote that there are Exchange Traded Funds (ETFs) that can outperform the S&P 500 (NYSEARCA:SPY) in the long-term, but they use different investing styles and have different volatility as well as risks. The examples I recommended in that article were the Vanguard Small-Cap (NYSEARCA:VB), Mid-Cap (NYSEARCA:VO) and growth (NYSEARCA:VUG) ETFs. Each of them outperformed the S&P 500 in the past 10 years, although their volatility and risks were also higher.
I want to expand upon this topic by sharing with you three more ETFs-suggested by other commenters in my previous article-that can also outperform the S&P 500 in the long-term. In addition, I will provide you with my analyses on them, so you can add them to your watch list or your portfolio, if you are comfortable with their growth prospects, risks and investing styles.
Note that different ETFs have different investing styles and risk levels. I suggest readers to invest for the long-term and buy stocks or ETFs when they are undervalued or when the market experiences significant drops-as it is happening at the time of writing this-to achieve a good margin of safety.
Vanguard Total Stock Market ETF
The Vanguard Total Stock Market ETF (NYSEARCA:VTI) is an exceptionally low-cost ETF-with an expense ratio of 0.05%-that tracks the performance of the CRSP U.S. Total Market Index (source: Vanguard). The ETF invests in nearly 100% of the U.S. equity market-including small, mid and large cap stocks with both growth and value styles.
This means that you would be investing in the entire U.S. equity market instead of applying a specific ETF investing style (e.g. value, growth, small or large cap ETFs). As long as the U.S. economy is continuously improving over the long-term, the Vanguard Total Stock Market ETF will continue to increase in value due to increasing earnings from the underlying stocks and/or the increasing capital that is flowed into the U.S. equity market.
In terms of performance, the ETF has outperformed the S&P 500 in the past 10 years (see image below) and will likely continue to outperform it, because it is also invested in small and mid cap stocks that tend to have higher revenue/earnings growth than large cap stocks. However, the large cap stocks' performances in the ETF still have the most weight because the ETF is 'weighted by market cap'.
In terms of volatility or risk, it is about the same as the S&P 500 even though the ETF has small and mid-cap exposure. As stated above, this is because the total returns of large cap stocks still have the most weight on the ETF compared with the small and mid cap stocks. This also means that the Vanguard Total Stock Market ETF can have a greater risk/reward ratio than the S&P 500.
Global X Guru Index ETF
The Global X Guru Index ETF (NYSEARCA:GURU) tracks the performance of the Solactive Guru Index, which is comprised of the top U.S. equity positions held by a selected group of hedge funds in the U.S. (source: Global X Guru). Hedge funds charge clients exceptionally high fees-e.g. a 2% management fee plus 20% performance fee-to help them look for attractive investment opportunities and outperform the market. Every quarter, hedge funds that have more than $100 million in U.S. equity investments report their holdings in a public form called the Form 13F. The Global X Guru Index ETF duplicates the top holdings of selected hedge funds every quarter and gives investors a much more cost-efficient way to achieve the same performance. The ETF's management fee is 0.75%.
Although the ETF only started in June 2012, I believe that the methodology and investment idea behind it are sound. Hedge fund managers are paid for finding the best investment ideas, and they generally have larger positions and have longer holding periods for their top ideas. If the Global X Guru Index ETF duplicates their top positions, the ETF should outperform the S&P 500 in most years (see image below).
The ETF has a higher level of risk/volatility than the S&P 500 because it is only comprised of 54 stocks at the time of writing (source: fund facts) and because the underlying stocks can also be small and mid caps, depending on the hedge funds' top holdings. However, I believe that the ETF's risk is not that much higher than the S&P 500's because the underlying stocks are screened for liquidity and are 'equally weighted'. Its beta is 1.12 compared with the S&P 500, as of Mar. 31 2014 (source: GURU).
First Trust U.S. IPO Index Fund ETF
The First Trust U.S. IPO Index Fund ETF (NYSEARCA:FPX) tracks the performance of the IPOX-100 U.S. Index, which is a "value-weighted index" based on the top 100 companies ranked quarterly by the IPOX Global Composite Index (source: First Trust). The IPOX-100 U.S. Index focuses on the top 100 largest and most liquid IPO stocks (mid and large-cap stocks) that are traded in the U.S. It uses a 10% capping on all of its stocks and adjusts its components every quarter. One interesting fact is that the index only measures the performance of top U.S. IPO stocks for the first 1,000 trading days or approximately 4 years. This means that the IPO stocks will automatically exit the index after 4 years. Note that the ETF's expense ratio is 0.65%.
In terms of performance, the ETF has outperformed the S&P 500 by a large margin since its inception in April 2006, and it should continue to outperform the S&P 500 in a bull market, because the ETF focuses on mid and large cap IPO stocks that tend to have large growth potential (see image below).
It has a higher level of risk/volatility than the S&P 500 because it focuses on IPO stocks. Even though its beta is only 1.12 relative to the Russell 3000 Index as of Mar. 31 2014, the ETF can be quite volatile when the market is not stable. You can see the ETF's larger price fluctuations relative to the S&P 500 for the first 3 months of 2014 (see image above).
The Bottom Line
The Vanguard Total Stock Market, Global X Guru Index and First Trust U.S. IPO Index Fund are great ETFs that can outperform the S&P 500 in the long run, but their investing styles and risk levels are also different. If you want an ETF that has a similar risk level as the S&P 500, the Vanguard Total Stock Market is the best one. The Global X Guru Index is also a great ETF since it focuses on hedge funds' top equity positions that generally represent their best and most convicted investment ideas. The First Trust U.S. IPO Index Fund ETF is likely for investors who want a higher growth potential but are willing to take on more risk.
If you want to trail the S&P 500 instead of beating it, you can follow Warren Buffett's latest advice from his 2013 shareholder letter:
My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard's) I believe the trust's long-term results from this policy will be superior to those attained by most investors - whether pension funds, institutions or individuals - who employ high-fee managers.
Sources: Vanguard, Global X Guru, First Trust and YCharts.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.