How To Avoid The Worst Style ETFs: Q1 2020

Mar. 26, 2020 12:11 PM ETBBUS, FLAG-OLD, BYOB, IPO, QVAL, SCHB, SFYF, VBK

Summary

  • The large number of ETFs has little to do with serving your best interests.
  • Below are three red flags you can use to avoid the worst ETFs.
  • The following presents the least and most expensive style ETFs as well as the worst overall style ETFs per our Q1'20 style ratings.
  • Looking for a helping hand in the market? Members of Value Investing 2.0 get exclusive ideas and guidance to navigate any climate. Get started today »

Question: Why are there so many ETFs?

Answer: ETF providers tend to make lots of money on each ETF so they create more products to sell.

The large number of ETFs has little to do with serving your best interests. We leverage our data to identify three red flags you can use to avoid the worst ETFs:

1. Inadequate Liquidity

This issue is the easiest issue to avoid, and our advice is simple. Avoid all ETFs with less than $100 million in assets. Low levels of liquidity can lead to a discrepancy between the price of the ETF and the underlying value of the securities it holds. Plus, low asset levels tend to mean lower volume in the ETF and larger bid-ask spreads.

2. High Fees

ETFs should be cheap, but not all of them are. The first step here is to know what is cheap and expensive.

To ensure you are paying at or below average fees, invest only in ETFs with total annual costs below 0.45%, which is the average total annual cost of the 516 U.S. equity Style ETFs we cover. The weighted average is lower at 0.14%, which highlights how investors tend to put their money in ETFs with low fees.

Figure 1 shows Exchange Traded Concepts Forensic Accounting Long-Short (FLAG) is the most expensive style ETF and JPMorgan BetaBuilders U.S. Equity ETF (BBUS) is the least expensive. Absolute Shares Trust (WBIL, WBIF) provides two of the most expensive ETFs while Schwab U.S. Broad Market ETF (SCHB) is among the cheapest.

Figure 1: 5 Most and Least Expensive Style ETFs

Sources: New Constructs, LLC and company filings

Investors need not pay high fees for quality holdings.[1] JPMorgan BetaBuilders U.S. Equity ETF (BBUS) is one of the best ranked style ETFs in Figure 1. BBUS’s Neutral Portfolio Management rating and 0.02% total annual cost earns it an Attractive rating.[2] Alpha Architect U.S. Quantitative Value ETF (QVAL) is one of the best ranked style ETFs overall. QVAL’s Attractive Portfolio Management rating and 0.54% total annual cost also earns it a Very Attractive rating.

On the other hand, Vanguard Small Cap Growth Index Fund (VBK) holds poor stocks and earns our Unattractive rating, yet has low total annual costs of 0.08%. No matter how cheap an ETF, if it holds bad stocks, its performance will be bad. The quality of an ETF’s holdings matters more than its price.

3. Poor Holdings

Avoiding poor holdings is by far the hardest part of avoiding bad ETFs, but it's also the most important because an ETF’s performance is determined more by its holdings than its costs. Figure 2 shows the ETFs within each style with the worst holdings or portfolio management ratings.

Figure 2: Style ETFs with the Worst Holdings

Sources: New Constructs, LLC and company filings

Invesco appears more often than any other providers in Figure 2, which means that it offers the most ETFs with the worst holdings.

Renaissance IPO ETF (IPO) is the worst rated ETF in Figure 2. SoFi Gig Economy ETF (GIGE) and SoFi 50 ETF (SFYF) also earn a Very Unattractive predictive overall rating, which means not only do they hold poor stocks, they charge high total annual costs.

Our overall ratings on ETFs are based on our stock ratings of their holdings and the total annual costs of investing in the ETF.

The Danger Within

Buying an ETF without analyzing its holdings is like buying a stock without analyzing its business and finances. Put another way, research on ETF holdings is necessary due diligence because an ETF’s performance is only as good as its holdings’ performance.

Performance of ETF's Holdings = Performance of ETF

Analyzing each holding within funds is no small task. Our Robo-Analyst technology enables us to perform this diligence with scale and provide the research needed to fulfill the fiduciary duty of care. More of the biggest names in the financial industry (see At BlackRock, Machines Are Rising Over Managers to Pick Stocks) are now embracing technology to leverage machines in the investment research process. Technology may be the only solution to the dual mandate for research: Cut costs and fulfill the fiduciary duty of care. Investors, clients, advisors and analysts deserve the latest in technology to get the diligence required to make prudent investment decisions.

Only our research utilizes the data and earnings adjustments featured by the Harvard Business School and MIT Sloan paper "Core Earnings: New Data and Evidence.”

This article originally published on Feb. 6, 2020.

Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.

[1] This paper compares our analytics on a mega cap company to other major providers. The Appendix details exactly how we stack up.

[2] Harvard Business School features the powerful impact of our research automation technology in the case New Constructs: Disrupting Fundamental Analysis with Robo-Analysts.

This article was written by

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New Constructs is an independent research technology firm that provides unrivaled insights into the fundamentals and valuation of private & public businesses. Combining human expertise with machine learning and NLP, the firm shines light into the dark corners (e.g. footnotes) of millions of financial filings and provides superior investment research. The firm's Robo-Analyst technology is the first-ever vertically integrated investment research platform: performing data collection, financial modeling and assigning investment ratings to over 10,000 securities - automatically. This new technology is research automation at its best according to:


   1. Harvard Business School & MIT Sloan prove our fundamental data is superior.


   2. Ernst & Young proves the superiority of our financial analytics over Capital IQ & Bloomberg.


   3. Indiana Kelly School of Business proves our stock ratings outperform human analysts.



If these prestigious institutions trust us so much that they decided to publish official papers to prove the superiority of our research, then you can safely trust us, too.

New Constructs' clients include investors of all types from quant funds like GSAM who subscribe to proprietary data feeds, advisors and individuals who subscribe to our investment research directly through our website.


David is CEO of New Constructs (www.newconstructs.com). David is a distinguished investment strategist and corporate finance expert. He was a 5-yr member of FASB's Investors Advisory Committee. He is author of the Chapter “Modern Tools for Valuation” in The Valuation Handbook (Wiley Finance 2010). 


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. I have no business relationship with any company whose stock is mentioned in this article.

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