The top 10 ETFs over the last five years were all sector and industry ETFs.

Technology ETFs accounted for four of the top 10 spots in this year’s list of the top five-year ETFs. Also prominent are aerospace and defense ETFs. These technology and defense funds reduced health care’s previous dominance to just three spots in the top 10 list, down from five last year. None of the top 10 ETFs over the last five years were holdovers from last year’s article.

The technology sector as a whole is now the best-performing category, gaining 18.1% on an annualized basis over the last five years. Health care ETFs are, on average, the second-best performing, gaining 17.2% over the last five years. Following the health care sector is the financial sector and large-cap stock categories, which have gained 15.5% and 14.3% over the same time period, respectively.

The technology sector tends to perform well during economic expansion, but its funds are volatile over time, as evidenced by a total risk index of 1.46. Due to the sector’s outperformance, technology stocks are close to 23% of the market weight of the S&P 500 index, the highest percentage since the tech bubble (the weighting peaked at 35% in March 2000).

As with other sectors, it’s important to understand whether an ETF is focused on a particular industry within the technology sector or if it is investing broadly in the sector. In the case of two of the top-performing ETFs over the last five years, iShares PHLX Semiconductor ETF (SOXX) and VanEck Vectors Semiconductor ETF (SMH), the focus is specifically on semiconductor-related stocks.

While these ETFs take advantage of favorable industry conditions, their limited focus also carries more risk. Both ETFs are highly concentrated: 61% of iShares PHLX Semiconductor’s portfolio is in its top 10 holdings, while VanEck Vectors Semiconductor has a 65% concentration in its top 10. Having a high concentration can pay off, but it also increases stock-specific risk.

It’s worth noting that while both ETFs are in the technology sector category, they track different indexes and also weight their top holdings differently. Nvidia (NVDA), Broadcom (BRCM), Intel (INTC) and Qualcomm (QCOM) are among the top five holdings for both ETFs; however, VanEck Vectors Semiconductor’s largest two holdings are Taiwan Semiconductor Manufacturing (TSM), with a weight of 12.5%, and Intel with a weight of 11.0%. On the other hand, iShares PHLX Semiconductor’s two largest holdings are Nvidia and Broadcom, with weights of 8.4% and 8.2%, respectively.

The top-performing health care ETFs target biotech companies are VanEck Vectors Biotech ETF (BBH) and First Trust NYSE Arca Biotechnology Index ETF (FBT). The biotechnology industry is one of the most volatile groups within the health care sector, and in many instances a biotech firm may have to endure long periods of heavy losses before a drug comes on the market and yields benefits. First Trust NYSE Arca Biotechnology Index fund is the most consistent top performer in the top 10 list: Since 2012, the ETF has been among the top 25% in its category four times (2012, 2014, 2015 and 2017 through June 30). VanEck Vectors Biotech ETF has an expense ratio of 0.35%, significantly lower than First Trust NYSE Arca Biotechnology Index ETF’s expense ratio of 0.56%. While First Trust NYSE Arca Biotechnology’s category risk index is higher than that of VanEck Vectors Biotech (1.48 versus 1.26), the latter ETF has only 26 holdings, and 70% of the portfolio’s assets are invested in the top 10 holdings. Comparably, First Trust NYSE Arca Biotechnology has 31 holdings, but only 38% of assets are invested in the 10 largest holdings.

All three of the top-performing industrial ETFs are concentrated in the aerospace and defense sector and invest entirely or primarily in U.S.-based firms. U.S. federal government defense spending was capped when automatic budget cuts took effect in 2013. However, several members of Congress have called for increases in defense spending and have been advocates of not cutting defense spending any further. Additionally, airlines have benefited in the wake of lower oil prices and previous restructuring.

Last year, PIMCO 25+ Year Zero Coupon U.S. Treasury ETF (ZROZ) and Vanguard Extended Duration Treasury ETF (EDV) were both among the top performers. With the Federal Reserve raising interest rates, it is not surprising to see a lack of fixed-income funds on the top 10 list this year: As interest rates rise, bond prices decline. Currently, interest rates are off of last year’s low, but are approximately even with two years ago.

When analyzing the top performers over the last five years, it’s important to consider the performance of the year that’s being dropped from the calculation, along with the year being added. This year, the five-year return calculation added 2016 and dropped 2011. In 2011, eight of the 10 top-performing ETF categories were fixed income. Long-term government bond ETFs, on average, made up the best-performing category in 2011, gaining 44.0%. Second place went to intermediate-term government bonds, which gained 17.2% in 2011. Their dominance occurred over a period when equity ETF returns were still adversely affected by the financial crisis.

As is the case with mutual funds, the return realized by an ETF is primarily influenced by its investment objective. If the category, industry group or style that a fund is designed to follow does well, the fund’s performance will benefit.

Other Top Performers

Within the large-cap stock ETF category, two Guggenheim ETFs made it into top positions, including Guggenheim S&P 500 Pure Value ETF (RPV) and Guggenheim S&P 500 Pure Growth ETF (RPG). Both of these funds are considered specialized in that they seek purely value-oriented or growth-oriented stocks within the S&P 500. The Guggenheim S&P 500 Pure Growth ETF weights its holdings according to the strength of their growth characteristics (sales growth, earnings growth, price momentum), in accordance with the index it is named for. Guggenheim S&P 500 Pure Value ETF weights by value factors (price-to-book ratio, price-to-sales ratio and price-earnings ratio), in accordance with the S&P 500 Pure Value index. Stocks that have both value and growth elements are eliminated as potential investments.

Guggenheim S&P 500 Pure Value was the only value-oriented ETF to make it to the large-cap top-performing list. Last year, value ETFs controlled the top positions in the large-cap category, while this year a majority of the top ETFs over five years are growth-oriented. Over the long term, value has outperformed growth. This held true over the last five years, although only to a marginal degree. Year to date, however, growth-oriented stocks have significantly outperformed value as investors have gained confidence in economic growth and anticipate less corporate regulation under the Trump administration.

The story was different for the mid-cap category’s top performers. Three of the five top-performing mid-cap ETFs are value-oriented, while the remaining two take a blended approach (both value and growth). Two dividend-oriented ETFs made it to the top: PowerShares High Yield Equity Dividend Achievers ETF (PEY) and WisdomTree U.S. MidCap Dividend ETF (DON). PowerShares High Yield Equity Dividend Achievers selects U.S. companies that have raised their dividend for at least 10 consecutive years, and from this group selects the 50 highest-yielding stocks and weights them by their trailing 12-month dividend yield. Seeking the highest-yielding stocks without regard to dividend sustainability makes this ETF’s approach more risky than many of its dividend-oriented peers. This is demonstrated by its comparatively high drawdown during the most recent bear market (the ETF lost 11.6 percentage points more than its category average).

Over the last five years, large-cap ETFs have, on average, gained an annualized 14.3%, compared to mid-cap and small-cap ETFs, which both gained 14.2% on average. However, for 2017 year to date (through June 30), large-cap stocks have gained 8.5% on average, while mid-caps have gained 6.7% and small-caps have gained 3.4%.

While large caps have outperformed domestically, small caps have outperformed overseas in both developed and emerging markets. Of the three top-performing foreign stock ETFs displayed on page 10, two invest in small-cap securities: WisdomTree International SmallCap Dividend ETF (DLS) and iShares MSCI EAFE Small-Cap ETF (SCZ). Despite having an expense ratio above its category average (0.58% versus 0.46%), WisdomTree International SmallCap Dividend has been among the 25% top-performing ETFs in its category over the last year and three-, five- and 10-year periods. iShares MSCI EAFE Small-Cap along with Deutsche X-trackers MSCI EAFE Hedged Equity (DBEF) are foreign stock ETF holdovers from last year’s five-year top-performers list.

Exchange rates and local economic conditions are two factors that have historically had a significant effect on foreign stock ETFs. It’s worth noting that central banks in the U.K., eurozone and Japan are all using aggressive monetary policies to keep interest rates low in hopes of stimulating demand. If foreign interest rates stay low as the U.S. begins to raise interest rates, the U.S. dollar could strengthen, which may hurt ETFs that don’t hedge currency exposure.

Which Funds Were Included

The list of top ETFs was largely restricted to those with five years of annual return data and a minimum of $450 million in assets. Exceptions were made if an ETF had assets below $450 million but a reasonable amount of daily trading volume. We consider assets and volume when determining which funds to include because we want to ensure that an ETF on the “top” list can be easily purchased and sold by individual investors. While assets and trading volume are not the only considerations when determining ETF liquidity, they are good starting points.

ETFs intended to provide double or triple the return of their underlying index or that follow inverse strategies (they rise in price when the underlying index falls) were excluded from consideration. These types of funds are designed to be held for short periods of time, especially those using three times leverage and/or are contra funds. Additionally, funds were excluded from consideration if their expense ratio was more than 50% above that of its category average, or their risk index was more than 50% higher than that of its category average. Higher expense ratios require higher returns just to break even with lower-cost funds. Additionally, past research has shown that funds with higher expense ratios underperform over time. While purchase decisions shouldn’t be based solely on expense ratios, if there is a less expensive alternative in the same category it may be worth investigating.

Higher risk doesn’t lead to higher returns, either, which brings us to the relative risk limitation. While higher risk can lead to higher returns, as is the case with some of the ETFs that were excluded from this year’s top list, better performance is not guaranteed in the future. Risk applies to the downside and upside; while it may boost returns during rising markets, it can also lessen returns during declining markets.

The downloadable spreadsheet shows the top ETFs by category. Five-year performance was calculated through June 30, 2017, to match the statistics displayed in “The Individual Investor’s Guide to Exchange-Traded Funds 2017,” which was published in the August 2017 AAII Journal.

In addition to five-year performance, returns for the year to date, the last 12 months and each of the past five years, as well as annualized three-year returns are displayed, along with returns for the most recent bull market (March 1, 2009, through June 30, 2017) and bear market (November 1, 2007, through February 28, 2009), where available. Returns that are in the top 25% of all exchange-traded funds within their investment category are shown in boldface. Other pertinent information presented includes yield, tax-cost ratio, risk, portfolio composition and expenses. Risk numbers that are in the lowest 25% of all ETFs within the investment category are shown in boldface. Five-year annual total returns based on market value are also displayed to show how closely each fund’s price performance matches its net asset value performance. The bigger the difference, the larger the premium or discount that fund shares have traded at over the period.

Why is a five-year time period desired? A five-year return is long enough that it balances consistency of performance with changing market and economic conditions. Five-year performance is used for our mutual fund comparison article (“The Top Mutual Funds Over Five Years: Health Care’s Dominance is Weakening,” March 2017 AAII Journal). Although most ETFs track indexes and are not influenced by active management as the majority of mutual funds are, looking at the longer five-year performance of ETFs is beneficial because it gives the same balanced perspective that a shorter period cannot.

Table 1 shows a list of the 50 top-performing funds, expanding on the top 10 displayed in the spreadsheet.

Table 1. Top 50 ETFs Based on Five-Year Performance

ETF Name (Ticker)	Category	5-Yr Ann’l NAV Return  (%)	Yield (%)	Expense Ratio (%)
Overall Five-Year Top Performers
iShares PHLX Semiconductor ETF (SOXX)	Technology Sector	23.5	1.0	0.48
VanEck Vectors Semiconductor ETF (SMH)	Technology Sector	22.4	0.7	0.36
VanEck Vectors Biotech ETF (BBH)	Health Sector	21.9	0.3	0.35
First Trust Dow Jones Internet ETF (FDN)	Technology Sector	21.8	0.0	0.54
iShares US Aerospace & Defense ETF (ITA)	Industrial Sector	21.3	1.0	0.44
First Trust NASDAQ-100-Tech Sector ETF (QTEC)	Technology Sector	21.2	0.7	0.60
iShares US Medical Devices ETF (IHI)	Health Sector	21.2	0.4	0.44
SPDR® S&P Aerospace & Defense ETF (XAR)	Industrial Sector	21.1	1.0	0.35
First Trust NYSE Arca Biotech ETF (FBT)	Health Sector	21.1	0.0	0.56
PowerShares Aerospace & Defense ETF (PPA)	Industrial Sector	21.0	1.4	0.64
PowerShares S&P SmallCap Info Tech ETF (PSCT)	Technology Sector	20.9	0.2	0.29
Guggenheim S&P 500® Eq Wt Technology ETF (RYT)	Technology Sector	20.2	0.8	0.40
Guggenheim S&P 500® Eq Weight HC ETF (RYH)	Health Sector	19.2	0.4	0.40
iShares Nasdaq Biotechnology ETF (IBB)	Health Sector	19.2	0.2	0.47
SPDR® Morgan Stanley Technology ETF (MTK)	Technology Sector	19.0	0.7	0.35
SPDR® S&P Insurance ETF (KIE)	Financial Sector	18.8	1.5	0.35
iShares US Financial Services ETF (IYG)	Financial Sector	18.5	1.3	0.44
iShares US Healthcare Providers ETF (IHF)	Health Sector	18.4	0.2	0.44
iShares North American Tech ETF (IGM)	Technology Sector	18.2	0.7	0.48
Vanguard Health Care ETF (VHT)	Health Sector	18.1	1.3	0.10
PowerShares QQQ ETF (QQQ)	Technology Sector	17.9	1.0	0.20
PowerShares KBW Bank ETF (KBWB)	Financial Sector	17.8	1.4	0.35
Financial Select Sector SPDR® ETF (XLF)	Financial Sector	17.8	1.5	0.14
Health Care Select Sector SPDR® ETF (XLV)	Health Sector	17.7	1.5	0.14
iShares North American Tech-Software ETF (IGV)	Technology Sector	17.6	0.1	0.48
iShares US Healthcare ETF (IYH)	Health Sector	17.6	1.1	0.44
WisdomTree Europe SmallCap Dividend ETF (DFE)	Int’l Stock (Reg/Country) - Europe	17.5	2.8	0.58
Vanguard Financials ETF (VFH)	Financial Sector	17.3	1.6	0.10
Guggenheim S&P 500® Pure Value ETF (RPV)	Large-Cap Stock	17.3	1.7	0.35
Fidelity® Nasdaq Composite Tr Stk ETF (ONEQ)	Large-Cap Stock	17.2	1.0	0.21
Consumer Discret Sel Sect SPDR® ETF (XLY)	Consumer Discretionary Sector	17.2	1.5	0.14
Vanguard Consumer Discretionary ETF (VCR)	Consumer Discretionary Sector	17.1	1.4	0.10
SPDR® S&P Regional Banking ETF (KRE)	Financial Sector	17.0	1.4	0.35
Vanguard Information Technology ETF (VGT)	Technology Sector	17.0	1.1	0.10
First Trust Health Care AlphaDEX® ETF (FXH)	Health Sector	16.8	0.0	0.61
First Trust Technology AlphaDEX® ETF (FXL)	Technology Sector	16.6	0.8	0.63
SPDR® S&P Bank ETF (KBE)	Financial Sector	16.6	1.4	0.35
PowerShares High Yld Eq Div Achiev™ ETF (PEY)	Mid-Cap Stock	16.5	3.2	0.54
iShares Global Tech ETF (IXN)	Technology Sector	16.5	0.8	0.47
First Trust Cloud Computing ETF (SKYY)	Technology Sector	16.4	0.4	0.60
iShares US Consumer Services ETF (IYC)	Consumer Discretionary Sector	16.3	1.1	0.44
Industrial Select Sector SPDR® ETF (XLI)	Industrial Sector	16.2	1.9	0.14
Vanguard Industrials ETF (VIS)	Industrial Sector	16.2	1.8	0.10
PowerShares Dynamic Pharmaceuticals ETF (PJP)	Health Sector	16.2	0.8	0.57
First Trust Financials AlphaDEX® ETF (FXO)	Financial Sector	16.2	1.5	0.64
iShares US Financials ETF (IYF)	Financial Sector	16.1	1.6	0.44
VanEck Vectors Morningstar Wide Moat ETF (MOAT)	Large-Cap Stock	16.0	1.0	0.49
Deutsche X-trackers MSCI Japan Hedged Eq (DBJP)	Int’l Stock (Reg/Country) - Pac Asia	15.9	2.4	0.45
iShares Morningstar Large-Cap ETF (JKD)	Large-Cap Stock	15.9	2.0	0.20
Technology Select Sector SPDR® ETF (XLK)	Technology Sector	15.8	1.5	0.14
Copyright 2017 American Association of Individual Investors and Morningstar, Inc. All Rights Reserved. Data as of June 30, 2017.

Look Beyond Performance

There is always a temptation to look more favorably at the best-performing funds. Though performance does matter, it is just one factor to consider.

You should also consider your portfolio needs. A basic allocation to ETFs holding domestic stocks with varying market capitalizations, international stocks, government bonds, corporate bonds and international bonds will serve most investors well. Once this basic portfolio allocation is established, other asset classes—such as real estate and commodities—and more specialized funds can be added.

Sector and country funds can boost a portfolio’s returns, but prudence is required when using them. Make sure you understand the factors that have driven a sector’s performance over the past few years and how likely it is that those trends will continue in the future. You cannot safely navigate a winding road by only using a rear-view mirror. Country-specific ETFs can allow you to target specific markets but can be more volatile and expose you to exchange-rate risks.

Be sure you fully understand the index that the ETF is designed to follow. Similar-sounding indexes can have different return characteristics. They can also either hold different stocks or weight the same stocks differently. A quick visit to an ETF family’s website can give you the list of current holdings and information about the underlying index that the fund tracks. Many index providers also give more detailed information about their indexes on their own websites. (Type the index’s name into an internet search engine, such as Google, to find the specific website.)

Finally, use this rule of thumb when looking at ETFs: “Just because you can invest in something, doesn’t mean you should.” Buy only those ETFs that you fully understand; avoid those that track indexes or invest in sectors or countries with risks that you cannot identify.

Related

Feature

The Individual Investor’s Guide to Exchange-Traded Funds 2017

Related

Exchange-Traded Funds

Why Aren’t There More Active ETFs?

Related

Exchange-Traded Funds

An Inside Look at Exchange-Traded Funds