How to analyze ETFs?

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After you have narrowed down a list of potential ETFs for your portfolio, how do you decide which one is the better fit? Not all ETFs that target the same strategy are made the same. In this post, I want to explore how to analyze ETFs to understand key metrics you should look out for.

Expenses

Starting with the obvious, Management Expense Ratio (MER) or, in other words, management fees. The cheaper the ETF, the more you get to keep for yourself.

ETFs are cheaper than mutual funds, that is why they have been so attractive, but they do vary in fees quite significantly, even across similar strategy ETFs. This is especially true if you are looking at a particular strategy.

For broader strategy ETFs, the fee difference might be negligible. For example, S&P 500 ETFs SPY and IVV.

IVV – Expense Ratio: 0.03%
SPY – Expense Ratio: 0.09%

But for specific strategy ETFs, those differences can add up pretty quickly. Here is a look at the most popular Gold ETFs and their expense ratios, for example.

GLD – SPDR Gold Shares – Expense Ratio: 0.40%
IAU – iShares Gold Trust – Expense Ratio: 0.25%
GLDM – iShares Gold MiniShares – Expense Ratio: 0.18%

However, cheapest doesn’t always mean better. It is just one of the criteria. In many cases the higher expense is justified but must always be part of your consideration.

When designing a portfolio, I look at the weighted average expense & what ETF contributes the most to the overall expense. You can see the weighted average expense and fee breakdown on all of our portfolios. Then, if possible I look for cheaper alternatives to minimize the expense.

Volatility

Any investment asset that trades live on the market will fluctuate in price. Volatility is inherent to investing. Volatility is not always a bad as price growth is part of volatility and is the thing that generates capital gains. Ideally, however, investors prefer steady price appreciation and not sporadic ups and downs.

I don’t look at volatility of an individual ETF but rather how it fits in my portfolio. For example, if I am a conservative investor with a lot of fixed income ETFs in my portfolio at 80+%, then adding a highly volatile Emerging Markets stock ETFs will not impact the overall portfolio’s volatility that much and might give me the necessary exposure I am looking for.

Generally speaking it doesn’t make sense to evaluate each ETF on its own but as comparison to its peers and its fit in your portfolio.

Typically I look at Annualized Standard Deviation of monthly returns. Here is an example for S&P 500 ETF – SPY.

SPY Annualized Standard Deviation of Monthly Returns

Level of Diversification

Buying an ETF will always achieve a level of diversification that buying individual stocks never will. You are buying a fund at the end of the day. But not all ETFs are diversified equally. Some ETFs are extremely balanced, allocating no more than a few percent to each individual holding. Others are more centric.

The way to find out if the ETF you are analyzing is very top heavy is to look at its Top 10 holdings.

Here is an example of the S&P 500 ETF SPY.

SPY Top 10 Holdings

SPY is quite Apple, Microsoft and Amazon heavy. These are the biggest companies in the world right now that is the reason why but this gives this ETF an over 27% exposure to the Information Technology sector.

At the time of writing, technology sector is trading at significant premium and once the downturn comes, it is likely that it will be the sector affected the most, given its frothy valuation. Keeping in mind that peak prices don’t necessarily mean that fundamentals don’t support it or that it’s not a good company to hold for the long term.

Another thing to consider is the depth of ETF holdings. In the case of S&P 500, it holds around 500 stocks (505 to be exact).

ETFs targeting a specific strategy might have much fewer holdings. Number of holdings increases your level of diversification but with it comes the impact of that diversification on performance.

Liquidity

Liquidity of an asset should always be a consideration. That said, if you are the type of investor who worries about ETFs liquidity then the amounts you plan to buy are too big for you to be reading this article. That’s not to say that I as an individual investor never ran into liquidity issues. There were instances where the micro cap stock I was holding didn’t have enough volume for me to be confident in selling my position quickly. With ETFs, however, I never ran into such problems because larger ETFs with significant daily trading volume, more often than not, provide what I am looking for.

Historical Performance

Historical results are not a guarantee of future results, yes. However, markets, in general, are cyclical machines. Waves of euphoria and greed are followed by waves of fear and conservatism. So knowing how a portfolio has performed during one of those periods is useful information. Does it mean it will perform exactly the same when another cycle hits, no, but it will have a higher probability of performing similarly unless the unforeseen happens?

History is not meaningless after all. Take a look at S&P 500 since 1920s.

S&P500 Monthly Returns since 1920

Source: S&P 500 Returns since 1920

The big ups and big downs but looking at the overall result, its solid 10% per year including dividends.

S&P500 Investment in 1920

Can we expect the same over the next 10,20,50 years? Not 10% per se but it gives me a certain level of confidence that unless the economy collapses, there will be businesses that will continue to generate value for society and we will be able to invest in them with a positive return on our investment.

Dividends

Not all ETFs pay dividends but for the ones that do I like looking at a few metrics.

Dividend Yield

What is the dividend yield that ETF is generating right now? Obviously, the yield will change with the ETF price. Here is an example for SPY.

SPY Dividend Yield

Dividend Growth Rate

Relative to its peers, have the dividend growth rate be higher or lower for the ETF I am analyzing? This analysis applies more to dividend-focused ETFs.

What I like to see is steady % growth for dividend focused ETFs. Here is an example for Vanguard High Dividend Yield ETF – VYM.

VYM Dividend growth rate

Asset Flows

Another metric that I like to consider is whether the money is flowing into a fund or is running away. Alone this doesn’t mean that fund is good or bad but if the money is consistently fleeing from the fund, it could be a sign of trouble that warrants further investigation.

To look at asset flows I look at total AUM (Assets Under Management) over the last few years. Here is an example for SPY vs. IVV.

SPY and IVV Total AUM Growth

Analyze ETFs as part of a whole

Lastly, none of these metrics make sense in isolation. Either we look at ETFs head-to-head, or we consider one ETF as part of our overall portfolio. Consider how much weight an ETF gets in your portfolio and understand how much risk or performance that ETF will likely contribute to the whole portfolio. This is how we approach every single analysis on our Ready Portfolios

As always,

Happy Investing!

Top EV ETFs Breakdown

I started my professional career in the automotive industry long before electric vehicles were a thing despite Tesla already existing.

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