Sponsored by CFRA Research
Investors are increasingly shifting to index-based equity ETFs, from actively managed mutual funds, benefitting from the lower fees and greater transparency. However, CFRA thinks too many investors still conduct due diligence on ETFs the way they have long done with mutual funds -- looking backward at the track record. CFRA's approach is different than other independent research providers as we provide a forward-looking perspective on what's inside and the costs, since that's what will drive an ETF in the coming weeks, months and years.
Whether the SPDR S&P 500 Index ETF (SPY), the ETF with the most assets, can continue to achieve double-digit returns as it did in 2016 and 2017 has nothing to do with the fund managers' skills at selecting stocks. SPY does a good job of tracking the widely-followed index, but has no control over how much Apple (AAPL) or ExxonMobil (XOM) is inside. As such, determining how well it performed relative to other large-cap funds over the past three years provides an investor with little insight for what's ahead for 2018.
We think the failure of many active large-cap mutual funds to keep up with the S&P 500 index is the result of their higher fees and often poor security selection. It is for that very reason that CFRA ranks SPY and approximately 1,100 other equity ETFs based on a combination of holdings analysis and ETF attributes. These include an independent review of the valuation and risk of the stocks inside the portfolio as well as the expense ratio, bid/ask spread and technical trends of the fund.
Our forward-looking ratings are updated daily to reflect any changes in our view of the holdings or of these ETF attributes. We rate mutual funds separately from ETFs and due to our unique approach, approximately 20% of the ETFs we rate do not have a three-year record. Meanwhile, we are regularly more positive on some ETFs with a three-year track record than other providers, while more negative on other ETFs. One such example is CFRA top-rated iShares Core High Dividend (HDV 87 Overweight), which is up just 8.3% in the three-year annualized period ended January 3. Though this lags behind the 9.0% gain for the S&P 500 Value index, we don't think this is how HDV should be assessed. Rather, CFRA is positive on the valuation and risk considerations of the holdings, based on STARS and S&P Global Credit Ratings. Examples of positions with CFRA buy recommendations include AT&T (T), Intel (INTC) and Procter & Gamble (PG). Meanwhile, HDV's modest 0.08% expense ratio and tight penny bid/ask spread further support a top rating from CFRA.
Another top-rated ETF from CFRA that is viewed less favorably by another independent research provider is Vanguard FTSE Emerging Markets Index ETF (VWO). The ETF's 7.6% three-year total return has lagged the MSCI Emerging Markets Index's 9.0% annualized gain. However, CFRA is positive on the underlying holdings, which include CFRA buy-recommended Tencent Holdings, Taiwan Semiconductor Manufacturing and China Construction Bank. In addition, VWO's 0.14% expense ratio and penny bid/ask spread, combined with a bullish technical trend, contribute to the ETF's high rating.
Independent research providers that focus on an ETF's track record can help you to see what has happened in the past. Yet, investors who look only backward when choosing an ETF are like car drivers that focus solely on the rearview mirror. By not using the front windshield they will miss out on many appealing investment ideas for the future. What will drive an ETF to perform well in 2018 has little to do with its past performance history and much more to do with the prospects of its holdings and its fees relative to others.