Exchange-traded funds (ETFs) are growing at an astronomical rate. U.S. assets are closing in on $4.25 trillion. The ETF share of total assets at investment firms has more than doubled to 17% from 8% at the start of the decade, while mutual funds have lost market share. The only problem with this explosive growth? The industry now boasts thousands of funds, making it difficult to determine the very best ETFs.
But investors are getting smarter about how they use ETFs in their portfolios. "After a decade of market gains, ETFs now play a unique role for investors as the foundation of a portfolio and also as vehicles that enable investors to be nimble," says Kari Droller, who oversees third-party mutual funds and ETFs at Charles Schwab.
We try to be nimble, too. Although a thorough review of the Kiplinger ETF 20 happens only once a year, we watch each fund closely. As you'll see below, we've noted where a couple of funds merit more scrutiny as interest rates stay steady and low. But for now, we're holding fast to our 20.
Read on for more analysis of our Kiplinger ETF 20 picks, which allow investors to tackle various strategies at a low cost.
Invesco S&P SmallCap Low Volatility
Total assets: $2.4 billion
Dividend yield: 2.4%
Expense ratio: 0.25%, or $25 per $10,000 invested
Small-cap stocks tend to produce bumpy returns. Over the past decade, the Russell 2000 small-company stock index has been 36% more volatile than the S&P 500. Invesco S&P SmallCap Low Volatility (XSLV, $51.33) is designed to smooth out the ride. So far, so good: Since this ETF launched in early 2013, it has outpaced two small-company stock benchmarks - the Russell 2000 and the S&P SmallCap 600 - on an annualized basis, with less volatility.
There are cheaper options, but none as steady. Over the past five years, the ETF has outperformed its peers - other low-volatility and traditional small-company stock ETFs - with lower volatility in both up and down markets. We view this ETF as a core small-company stock holding.
The stock-picking process is simple. XSLV tracks a subset of the S&P SmallCap 600 Index that comprises 120 of the least volatile stocks, measured over the past 250 trading days. Stocks with the lowest volatility scores have a heftier rank in the portfolio regardless of market value. The ETF is nimbler than some of its peers because it recalculates the portfolio's constituents and rankings every three months, instead of twice a year.
But it's worth noting that exposures to certain sectors in the ETF can get lopsided; the fund doesn't employ any constraints to stay in line with its parent index, the S&P SmallCap 600. These days, XSLV has almost 70% of assets invested in financial services and real estate stocks combined, more than twice the exposure of the S&P SmallCap 600. The high concentration in dividend-rich sectors gives the fund a yield of 2.4%. Real estate investment trust (REITs) Redwood Trust (RWT) and commercial mortgage lender Granite Point Mortgage Trust (GPMT) are among the ETF's top holdings.
iShares Core S&P 500
Total assets: $207.6 billion
Dividend yield: 2.0%
Expense ratio: 0.04%
The S&P 500 is synonymous with the U.S. market and is the benchmark against which most large-cap managers are judged. Stocks such as Apple (AAPL), Exxon Mobil (XOM) and Bank of America (BAC) dot its holdings.
The SPDR S&P 500 ETF Trust (SPY) is the biggest S&P 500 tracker out there. However, the iShares Core S&P 500 (IVV, $330.23) has a key structural advantage over it. It is structured as an ETF, and thus, dividends - a key driver of index returns - are automatically reinvested. The SPY, however, is structured as a unit investment trust. As such, dividends from the SPY's underlying holdings must be held as cash until they are distributed to shareholders.
iShares Core S&P Mid-Cap
Total assets: $54.1 billion
Dividend yield: 1.6%
Expense ratio: 0.06%
The iShares Core S&P Mid-Cap (IJH, $206.10) is a pure play on mid-cap stocks, which offer almost all of the advantages of small caps but with much less risk, yet also boast more upside over the long haul than many large-cap stocks. Over the past 15 years, for instance, the S&P MidCap 400 has returned an annualized 9.9%, which beats the 9.4% gain in the S&P 500 and the 9.6% return in the S&P SmallCap 600 index.
The average market value of holdings in the Core S&P Mid-Cap ETF is $5.5 billion. By contrast, the average market value of companies in its sister fund, the iShares Core S&P 500 ETF, is $125.8 billion.
SEE ALSO: The 20 Best Stocks to Buy for 2020
Vanguard Total International Stock
Total assets: $19.4 billion
Dividend yield: 3.1%
Expense ratio: 0.09%
Vanguard Total International Stock (VXUS, $55.70), which holds more than 7,000 stocks, offers exposure to companies of all sizes in foreign countries large and small. Because it weights stocks by market value, the biggest companies dominate the fund; the average market value of its holdings is $24.9 billion.
Overall, VXUS has about 77% of its assets in developed markets, led by Japan at 7%. Emerging-markets stocks in developing countries such as China, India and South Korea round out the fund.
SEE ALSO: The 10 Best Vanguard Funds for 2020
Vanguard Total Stock Market
Total assets: $144.1 billion
Dividend yield: 1.8%
Expense ratio: 0.03%
Vanguard Total Stock Market (VTI, $167.11) gives you the entire U.S. stock market: large, midsize and small companies.
VTI tracks the CRSP U.S. Total Market Index, which includes some 3,600 stocks, making it a broader market proxy than the S&P 500. But the fund is similar in makeup to the S&P 500 because holdings are weighted by market value. Among the top holdings in Total Stock Market ETF are heavy hitters such as Microsoft (MSFT), Apple and Amazon.com (AMZN), all of which appear at the top of the S&P 500, too. As a result, the ETF's return rarely deviates from the S&P by more than 1 percentage point or so in any calendar year.
Schwab US Dividend Equity
Total assets: $12.0 billion
Dividend yield: 3.0%
Expense ratio: 0.06%
Schwab US Dividend Equity (SCHD, $58.84) invests only in dividend stocks that have paid investors every year for at least 10 years, that boast a market value of at least $500 million, and whose shares have significant daily trading volume. Finally, only those companies with the best relative financial strength - as measured by four factors, including return on equity and five-year dividend growth rate - make the cut.
Vanguard Dividend Appreciation
Total assets: $43.2 billion
Dividend yield: 1.7%
Expense ratio: 0.06%
Vanguard Dividend Appreciation (VIG, $127.83) is more concerned with whether a company has consistently boosted its annual dividend than its dividend yield. The fund tracks an index of large companies that have raised their annual payouts for at least 10 consecutive years. Limited partnerships, REITs and financially troubled companies are not eligible for inclusion.
VIG's focus on profits and dividend growth results in a higher-quality portfolio, says Morningstar analyst Adam McCullough. "It reduces the fund's exposure to firms that may not be able to sustain their dividend payments, which is a risk that often accompanies a narrow focus on yield," he says.
WisdomTree Global ex-US Quality Dividend Growth
Total assets: $108.5 million
Dividend yield: 1.9%
Expense ratio: 0.58%
WisdomTree Global ex-US Quality Dividend Growth's (DNL, $67.14) name suggests that it invests in international companies that increase their dividends - and ultimately, it does. But it takes a winding path to get there.
The fund invests in growing, high-quality dividend-paying firms in emerging and developed countries. The quality screen sorts companies by their historical return on equity and return on assets (both are measures of profitability). The growth screen zooms in on three- to five-year earnings growth expectations. "We created the same quality and growth screens that Warren Buffett likes," says WisdomTree's Jeremy Schwartz.
DNL's stocks are weighted by dividend payments - the bigger the annual payout, the bigger their share of the fund's assets. Top holdings include British American Tobacco (BTI) and drug company Novo Nordisk (NVO).
Total assets: $2.0 billion
Dividend yield: N/A
Expense ratio: 0.75%
Ark Innovation (ARKK, $52.80) offers investors an efficient way to get in on some of the biggest groundbreaking advancements changing lives today. The actively managed ETF invests in stocks set to benefit from one of five future trends: DNA sequencing and the gene therapies that are born from it; robotics; energy storage (think electric cars); artificial intelligence; and blockchain technology (the algorithms behind digital currencies). Electric automaker Tesla (TSLA) is the ETF's biggest holding, followed by payments-tech company Square (SQ) and gene sequencing firm Illumina (ILMN).
This is a shoot-the-moon investment, not a core holding. ARKK holds 37 stocks, which represent what Ark Invest ETF Manager Catherine Wood calls the money-management firm's "best ideas." Ark Invest also steers four additional active ETFs that target a single "disruptive innovation" theme, including Ark Next Generation Internet ETF (ARKW) and Ark Genomic Revolution (ARKG). Wood has a team of 20-odd analysts and traders working on those and on Ark Innovation ETF, which spans all of the themes. "We believe each stock in the portfolio will deliver a minimum 15% annualized return over the next five years," says Wood, though she concedes they may not be right about every single holding.
Over the past three years, Ark Innovation has returned an annualized 36.0%, which is more than two times the S&P 500. But buckle up, because the ride has been extremely uneven. Over that period, the ETF was more than twice as volatile as the S&P 500.
Wood uses the turbulence to the fund's advantage. Consider Tesla, whose stock price bounces around a lot. In August 2018, shares hit $380. The stock dropped to $250 months later and then rocketed to $377 in early December 2018. In June 2019, shares were down to $223. "Innovation is controversial, so we lie in wait for controversy in order to build our positions," Wood says. "We buy shares at the lows and sell at the highs."
The trimming and padding of holdings adds to turnover, which at 80% is typical for a fund that focuses on tech stocks. But Wood is generally a buy-and-hold investor. Based on changes in holdings that shift in and out of the portfolio entirely, she says, the fund's turnover is closer to 15%.
SEE ALSO: The 15 Best Tech Stocks to Buy for 2020
Fidelity MSCI Industrials Index
Total assets: $473.8 million
Dividend yield: 1.7%
Expense ratio: 0.08%
Fidelity MSCI Industrials Index (FIDU, $43.02) tracks an index of roughly 340 industrial stocks, in businesses ranging from construction equipment and factory machinery makers to aerospace and transportation.
The fund currently emphasizes giants such as Boeing (BA), Union Pacific (UNP) and Honeywell International (HON). These firms generate much of their sales overseas and would benefit from strong economic growth abroad and a weaker U.S. dollar, which also makes profits earned in foreign currencies worth more when converted to greenbacks.
Just under one-third of FIDU consists of small and midsize stocks. Smaller companies provide more exposure to sub-industries - such as electrical equipment, construction and engineering - and that adds to the fund's diversification. The fund's annual expense ratio of 0.08% is lower than that of any other industrials-focused ETF.
Financial Select Sector SPDR
Total assets: $25.9 billion
Dividend yield: 1.9%
Expense ratio: 0.13%
The Financial Select Sector SPDR (XLF, $30.39) holds commercial banks such as JPMorgan Chase (JPM) and Wells Fargo (WFC) as well as insurers, financial-services firms and investment banks - a sector that's sensitive to changes that politicians in Washington might make to both regulations and interest rates.
But XLF's top holding is Berkshire Hathaway (BRK.B), run by legendary investor Warren Buffett. Although Berkshire's big insurance unit gives it a lot of financial exposure, the company has stakes in everything from food products to railroads. No matter how the political winds blow in Washington, Berkshire should thrive.
Invesco S&P 500 Equal Weight Health Care
Total assets: $800.3 million
Dividend yield: 0.5%
Expense ratio: 0.40%
If you want the long-term growth of health-care stocks but worry about a rough landing for high-flying biotech stocks, look no further. Invesco S&P 500 Equal Weight Health Care (RYH, $225.35) takes the 61 health-care stocks in the S&P 500 and weights them equally. Thus, stocks such as PerkinElmer (PKI) and Incyte (INCY) have just as much say in the company's performance as companies such as Pfizer (PFE) and CVS Health (CVS).
Pharmaceutical stocks represent 16% of RYH's assets, compared with 28% in the typical health-care ETF.
iShares Edge MSCI Min Vol USA
Total assets: $38.4 billion
Dividend yield: 1.9%
Expense ratio: 0.15%
The iShares Edge MSCI Min Vol USA (USMV, $67.75) is an ETF that holds up well in rocky markets (Min Vol stands for minimum volatility). The fund tilts toward stocks of steadier large and midsize U.S. companies. "By reducing overall volatility, the fund delivers market-like returns with lower risk," says Holly Framsted, head of smart-beta ETFs for BlackRock's iShares. Over the past five years, iShares Edge MSCI Min Vol USA was 25% less jumpy than the S&P 500, and it beat the benchmark by a hair (an average of 0.4 percentage points per year) with a 12.6% annualized return.
Low-volatility funds tend to lag the market in good times but lose less in tough times. In 2017, when the S&P 500 gained 21.8%, USMV trailed, but only by a bit, with an 18.9% return. But in late 2018, when the broad market index sank 19.4%, iShares Edge MSCI Min Vol USA lost only 12.6%.
iShares MSCI USA ESG Select
Total assets: $1.2 billion
Dividend yield: 1.5%
Expense ratio: 0.25%
The iShares MSCI USA ESG Select (SUSA, $137.55) focuses on environmental, social and corporate governance characteristics to pick stocks. If you think ESG investing involves some tree-hugging, you're right. But it is more than that. The best firms based on ESG criteria are mindful of their environmental impact but also treat employees, customers and their community well and have a diverse pool of ethical managers who are aligned with shareholder interests. All of these characteristics (and more) add up to well-run firms that perform better over time, the thinking goes.
In other words, ESG tenets make good business sense and thus good investment sense.
ESG ratings can help identify a firm's problems before they come to light and snarl the stock. MSCI, a data provider that rates firms on ESG factors, flagged data and privacy issues at Equifax (EFX) and downgraded the company's ESG score to the lowest possible rating a full year before hackers breached the credit-reporting agency's database. (MSCI's ESG ratings resemble bond credit ratings and range from the best, triple-A, to the worst, triple-C.) Analyzing companies through an ESG lens can "catch problems in advance," says Todd Rosenbluth, a CFRA mutual fund and ETF analyst.
Investors are clamoring for ESG-focused ETFs. Assets in this category ballooned in 2019, according to Morningstar. Not surprisingly, dozens of promising, socially conscious ETFs have launched in recent years. But we're wary of recommending funds with such short track records. iShares MSCI USA ESG Select has been around since 2005 and boasts one of the longest track records in socially responsible investing.
What's more, its index tracks the best of the MSCI ESG-rated companies. After eliminating companies that make tobacco products, weapons, alcohol or nuclear power, or are involved with gambling, the index targets firms with the highest MSCI ESG ratings. According to BlackRock, 73% of the holdings in the index and the ETF have a triple-A or double-A MSCI ESG rating - the two highest ratings. The 100 stocks in the ETF are ranked by their ESG rating (the better the rating, the bigger the firm's representation in the fund), and the portfolio is rebalanced four times a year. Microsoft, Ecolab (ECL) and Apple are top holdings.
Over the past three years, SUSA has returned 15.4% annualized, just ahead of the S&P 500's annual average gain of 15.3%.
Pimco Active Bond
Total assets: $3.0 billion
SEC yield: 2.5%
Expense ratio: 0.55%
PIMCO Active Bond (BOND, $108.94) is, as its name suggests, an actively managed ETF (most ETFs merely seek to match an index).
Pimco has seen a good bit of turmoil in past years with the resignation of co-founder Bill Gross (who just retired from Janus Henderson), but we think the firm still has a lot of talent. Managers David Braun, Jerome Schneider and Daniel Hyman currently favor securitized debt, mostly government-guaranteed agency mortgage-backed securities, over Treasuries these days. About 24% of the fund's assets are invested in investment-grade corporate bonds, in line with the benchmark, Bloomberg Barclays U.S. Aggregate Bond index.
BOND has a duration of 5.3 years, which implies a 5.3% decline in net asset value if interest rates rise 1 percentage point.
SPDR DoubleLine Total Return Tactical
Total assets: $3.4 billion
SEC yield: 2.8%
Expense ratio: 0.55%*
We're fans of Jeffrey Gundlach, a comanager of this actively managed ETF with Philip Barach and Jeffrey Sherman. Gundlach and Barach also run DoubleLine Total Return Bond (DLTNX), with newly named comanager Andrew Hsu. The mutual fund is a member of the Kiplinger 25, the list of our favorite no-load mutual funds. But the fund and the ETF are not clones.
SPDR DoubleLine Total Return Tactical (TOTL, $49.26) draws on the view of Gundlach and his asset allocation team on the global economy and world markets. The ETF currently invests mostly in bonds with credit ratings of BBB or better (almost 70% are top-rated AAA) that it deems attractively priced.
But almost anything goes. The fund can invest in corporate debt, government bonds, floating-rate securities, foreign corporate and government IOUs, and Gundlach's bailiwick - mortgage-backed and asset-backed securities. There are some guard rails. No more than 25% of the ETF's net assets can be invested in high-yield debt, and no more than 15% in foreign-currency-denominated securities. But there is no cap on mortgage-backed securities. At last report, TOTL had 44.4% of its assets invested in MBSes and 25.6% in Treasuries.
DoubleLine Total Return Tactical yields 2.8% and its duration is 3.9 years, implying that if rates were to fall by 1 percentage point, the fund's net asset value would drop 3.9%.
* Includes a 10-basis-point fee waiver through at least Oct. 31, 2020.
Invesco Senior Loan Portfolio
Total assets: $6.3 billion
SEC yield: 4.0%
Expense ratio: 0.65%*
Invesco Senior Loan Portfolio (BKLN, $22.72) holds loans made by banks to heavily indebted firms with poor credit ratings. These junk-rated borrowers are charged "floating" interest rates that are typically tied to a short-term benchmark. When the short-term benchmark rises above a certain level, rates on these loans bump up, helping them hold their value better than bonds.
The portfolio at the moment includes 120 holdings, with more than half of that invested in debt that has earned a low B rating.
* Includes a 1-basis-point fee waiver through at least Aug. 31, 2020.
iShares Ultra Short-Term Bond ETF
Total assets: $2.8 billion
SEC yield: 2.0%
Expense ratio: 0.08%
The iShares Ultra Short-Term Bond (ICSH, $50.42) is an actively managed fund that holds a mix of high-quality bonds with one- to three-year maturities.
More than 75% of the portfolio - a mix of short-term corporate notes, investment-grade floating-rate bonds and some certificates of deposit - is rated single-A or better. (Investment-grade ratings start at triple-B and go up to triple-A.) What's more, ICSH has a low 0.4-year duration. That means if rates were to rise by 1 percentage point, the fund's net asset value would fall a mere 0.4%.
Pimco Enhanced Low Duration Active
Total assets: $464.5 million
SEC yield: 2.1%
Expense ratio: 0.79%
The managers behind Pimco Enhanced Low Duration Active (LDUR, $100.28) - Hozef Arif, David Braun and Jerome Schneider - are Pimco veterans. Their goal is to keep the portfolio's sensitivity to interest-rate moves low. As a result, the ETF currently has a 2.3-year duration. That implies that if interest rates overall were to rise by 1 percentage point, the fund's net asset value would drop by roughly 3.3%. Compare that with the five-year-plus duration of the broad bond market bogey, the aforementioned Agg index.
The fund's yield is boosted in part by investment-grade corporate debt, government-related debt, securitized debt and a smattering of exposure to emerging-markets and high-yield corporate debt.
When we added to Pimco Enhanced Low Duration Active to the Kip ETF 20 roster in mid 2018, we considered it a way to play defense against rising interest rates. In mid-2019, however, the Federal Reserve cut short-term interest rates. And for now, the Fed has indicated it will hold rates steady and doesn't expect to raise rates until a sustained and significant uptick in inflation. We'll be watching this fund - and interest rates and inflation - closely over the next few months.
Vanguard Total International Bond
Total assets: $25.2 billion
SEC yield: 0.53%
Expense ratio: 0.09%
Vanguard Total International Bond (BNDX, $57.26) tracks an index of foreign bonds, primarily government and quasi-government debt issued mostly in developed countries (though 4.6% of the portfolio's assets are in emerging-markets debt, at last report).
Because the fund holds bonds issued in local currencies, not U.S. dollars, Total International Bond hedges against currency risk to smooth out the ride as currency fluctuations can double the volatility of a global bond fund. This feature sets it apart from many world bond funds.
The caveat is BNDX's duration of eight years, implying an 8% decline in net asset value for every one-point rise in rates. Although interest rates abroad are currently low (or even negative) and expected to stay that way for the time being - especially in Japan and Europe, where much of the fund's assets are invested - when interest rates eventually rise, it could crimp returns.
We'll be keeping an eye on that.
SEE ALSO: The Best Online Brokers
Copyright 2020 The Kiplinger Washington Editors