I like ETF investing. They provide instant diversification. Most index-based versions have minimal fees and seldom issue capital gains, unlike their CEF and MF cousins. Between indexed and actively managed ETFs, are factor-based ETFs which try matching a non-vanilla version of a benchmark. Several recent SA articles picked one or two factor-based ETFs to compare against SPY. This article includes some of those and I added a few others I am aware of. This is more than an academic exercise as I am looking to expand my large-cap equity exposure and wondered if there was a better ETF than SPY.
ETFs used in my analysis:
Author's Note: All the brief descriptions are from Fidelity.com
SPDR S&P 500 (SPY): The investment seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the S&P 500® Index. The Trust seeks to achieve its investment objective by holding a portfolio of the common stocks that are included in the index (the “Portfolio”), with the weight of each stock in the Portfolio substantially corresponding to the weight of such stock in the index.
VanEck Vectors Morningstar Wide Moat ETF (MOAT): The investment seeks to replicate as closely as possible, before fees and expenses, the price and yield performance of the Morningstar® Wide Moat Focus IndexSM. The fund normally invests at least 80% of its total assets in securities that comprise the fund's benchmark index. The index is comprised of securities issued by companies that Morningstar, Inc. ("Morningstar") determines to have sustainable competitive advantages based on a proprietary methodology that considers quantitative and qualitative factors ("wide moat companies"). The fund is non-diversified.
SPDR S&P 500 Dividend (SDY): The investment seeks to provide investment results that, before fees and expenses, correspond generally to the total return performance of the S&P High Yield Dividend Aristocrats Index. The fund generally invests substantially all, but at least 80%, of its total assets in the securities comprising the index. The index is designed to measure the performance of the highest dividend-yielding S&P Composite 1500® Index constituents that have followed a managed-dividends policy of consistently increasing dividends every year for at least 20 consecutive years. The fund is non-diversified.
Invesco S&P 500 Low Volatility ETF (SPLV): The investment seeks to track the investment results (before fees and expenses) of the S&P 500® Low Volatility Index (the "underlying index"). The fund generally will invest at least 90% of its total assets in the securities that comprise the underlying index. Strictly in accordance with its guidelines and mandated procedures, the index provider selects 100 securities from the S&P 500® Index for inclusion in the underlying index that have the lowest realized volatility over the past 12 months as determined by S&P DJI.
Invesco S&P 500 High Dividend Low Volatility Portfolio ETF (SPHD): The investment seeks to track the investment results (before fees and expenses) of the S&P 500® Low Volatility High Dividend Index (the "underlying index"). The fund generally will invest at least 90% of its total assets in the securities that comprise the underlying index. The index provider compiles, maintains and calculates the underlying index, which is composed of 50 securities in the S&P 500® Index that historically have provided high dividend yields with lower volatility.
Invesco Exchange-Traded Fund Trust II - Invesco S&P 500 Momentum ETF (SPMO): The investment seeks to track the investment results (before fees and expenses) of the S&P 500 Momentum Index (the "underlying index"). The fund generally will invest at least 90% of its total assets in the securities that comprise the underlying index. The underlying index is designed to track the performance of approximately 100 stocks in the S&P 500® Index that have the highest "momentum score." In general, momentum is the tendency of an investment to exhibit persistence in its relative performance; a "momentum style" of investing emphasizes investing in securities that have had better recent performance compared to other securities. It is non-diversified.
Reason I chose each ETF:
MOAT: Factor is unique amongst ETFs - the idea that a stock should provide alpha because of their unique place within its sector.
SDY & SPHD: Extra income is a theme of many articles on SA so these allowed me to test the idea of earning income without a drop in performance.
SPLV: Another factor getting many articles is the ability to outperform in down markets by focusing on low volatility stocks. SPHD qualifies for this factor too.
SPMO: Momentum is a concept that people have been trying to master to gain alpha for years. This ETF allows us to see if it managed that feat.
SPY: I believe most investors, if they benchmark S&P 500 returns, would use SPY. Other contributors have in their comparison articles.
Comparing the choices:
Source: Fidelity.com & PortfolioVisualizer.com (only available from 2016) Compiled by Author
Adding two factors into one ETF doesn't give you the benefit of both as SPHD was the worst 3-year performer in the group despite using both High-Yield and Low Volatility factors. It also came in last for those with 5-year performance data.
SPMO performed the best since 2016 but did it by concentrating on their Top 10 holdings, resulting in a concentration risk twice as much as any other option – nearly 5x compared to SPY.
SPMO's history only covers one major correction, last fall, and it did the worst during that period. Being momentum-oriented, that would be expected.
Only MOAT outperformed SPY in both the 3 & 5-year returns. Even better, it did it with a lower beta.
Except for SPMO, going away from SPY will cost you 15-40bps in annual performance due to higher fees.
If you are looking to stay invested and have better downside protection than SPY, all the alternatives provide that except for SPMO.
If you believe faster growing companies is what you want in your ETF, then avoid SPLV, SDY and SPHD as their EPS growth rates are near or below 50% of the other alternatives.
There is a high percentage of overlap in the top 4 sectors each ETF uses. This reduces the concern that the factor-based ETFs are taking large sector bets to achieve their investment mandate.
None of the alternatives will beat SPY in all market environments.
Looking at each ETF:
I ran these based on each ETF's inception date, which is listed above. Data and graphs are from PortfolioVisualizer.
For SDY, I added a comparison to VTI, Vanguard's Extended Market ETF since SDY is based on the S&P 1500 index. For those wanting exposure beyond LC stocks, that is a plus. Another point is SDY has little Tech exposure whereas the other two ETFs have over 20% in Tech stocks. Based on the above statistics, SDY seems to provide no advantages over either VTI or SPY.
If you are looking for income from dividends, SPHD is the best alternative reviewed but you pay for that in total return in recent years. If fearing a correction, due to its low beta, it should outperform in that environment. Other than that, there are better investment vehicles to use if income is your top priority.
If looking to enhance your portfolio income, instead of SDY or SPHD, consider increasing your allocation to REITs, BDCs, or PFD-oriented funds.
SPLV, considering its beta and standard deviation, is providing the investor what they want - S&P return with a less risk. In a raising interest rate environment, I would be concerned as the top three sectors are all interest rate sensitive. That concentration in those sectors accounts for the slight increase in income over SPY.
I expressed some of my concerns about SPMO in my observations, mainly that it has less than four years of data. Looking at the chart, its outperformance has only been since 2017. Since it did poorly at the end of 2018, I would wait to see how it handles a correction before making a long-term investment in this ETF. For market timers, this is an ETF I would consider using.
MOAT has provided 89bps annually in extra performance since its inception in 2012. Though the chart doesn't seem to show it, it has the highest beta and standard deviation of the alternatives and its Sharpe & Sortino ratios say investors did not earn enough return for the risks taken. Some of that lack of return is explained by the high expense ratio.
Selecting an ETF to use instead of SPY is best done for reasons other than enhanced returns. Using data back to 2012, MOAT's CAGR was the highest at 14.05%; yet that was only 8bps better than SPY and MOAT needed a higher standard deviation to achieve that small outperformance (13.6 versus 11.4). As shown over the last three years, I would expect SPMO to outperform in raising markets (high beta indicates that too). If you think a correction is due, going with a lower beta should provide some downside protection and allow you to keep the same equity ratio.
As with any article I write, no investment advice is being given, just ideas for readers to explore. You should be able to find other articles that go into more detail on most of the ETFs mentioned in this article. If you want to know when I get published next, click "Follow" next to my pen name.
Disclosure: I/we 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.
Additional disclosure: As with any article I write for SeekingAlpha, no investment advice is implied. The purpose is to provide readers a starting point for their own research into any investment mentioned. I currently plan on purchasing MOAT after the exclusion period ends.