Tips for Selecting the Right ETFs for the Long Haul

The size and scope of the exchange traded funds industry is simply staggering when considering it’s barely more than three decades old.

As of the end of February, there were nearly 3,300 US-listed exchange traded products (ETPs) with $8.4 trillion in combined assets under management, according to ETFGI. While the number of mutual funds still dwarfs that of ETFs, the latter’s population growth has been breathtaking.

Take it from me – I’ve been covering ETFs for about 15 years now and I’ve seen the rapid pace at which new products come to market. Or don’t take my word and simply focus on this statistic: There were just 100 ETFs trading on U.S. exchanges at the end of 2003.

Regarding the indomitable rise of ETFs’ assets under management, advisors have played a pivotal role, but it’s debatable whether or not they’ve much, if anything, to do with ETF population growth. They probably haven’t because, logically speaking, more products imply more time allocated to evaluating those funds as well as increased probabilities that some of the goods coming to market aren’t useful. Fortunately, there are some basic steps advisors can take to make ETF evaluation easier.

Solid Ideas for Effortless ETF Evaluation

Alright, so I took some liberties using “effortless” above, but there are some easy ways advisors can reduce the ETF evaluation burden. While many investors have lost site of the merit of long-term investing, a broad swath of plain vanilla fit the bill as ideal for long-term investors and clients.

With that in mind, can take further steps to narrow the field of consideration by eliminating products with exceptionally high fees or complicated investment objectives. Fees aren’t the end all and be all of ETF evaluation, but clients like saving money and the higher an ETF’s fee is, the more work its holdings have to do to generate attractive outcomes.

Related to fees, total cost of ownership, which encompasses a fund’s turnover, liquidity and other issues, is another factor point that can help advisors reduce ETF evaluation burdens.

Another factor to consider is age. In a perfect world, new ETFs wouldn’t receive such harsh treatment, but many market participants, including advisors, like funds with extensive track records. There’s some merit to that line of thinking, particularly in pursuit of long-term ideas. If nothing else, when advisors screen ETFs based on age and size, they significantly pare the universe.

“A stricter $1 billion threshold confers some additional benefits. It cuts the pool down to just 599 ETFs. While nothing is guaranteed, those reaching the $1 billion mark are more likely to stick around. It takes time, often years, to grow that large,” notes Morningstar analyst Daniel Sotiroff. “The median life span of those 599 ETFs was 13.5 years, meaning most have a substantial track record that helps facilitate further analysis. Their real-world performance can be vetted against expectations. And their mature markets likely reduce trading costs for investors compared with newer ones.”

Some Pitfalls to Avoid

Screening ETFs by assets under management is effective in terms of narrowing the playing field. As noted above, less than 20% of the ETPs listed in the U.S. have $1 billion or more in assets. However, advisors need to recognize that screening that way doesn’t ensure they’ll find the best funds in terms of performance.

They probably won’t. After all, if the most popular investment was often the best-performing option, there’d be a lot more millionaires walking around.

Related to that, evaluating ETFs based on branding isn’t a guarantee of promise, but it can help advisors find low-fee products that appropriate for inclusion in a wide variety of client portfolios. Additionally, the biggest ETF issuers are also usually behind the biggest the funds, meaning there’s reduced risk of encountering funds heading for the ETF graveyard. That said, this is definitely an imperfect science and there scores of ETFs out there from smaller issuers that merit consideration, too.

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