The exchange-traded fund (ETF) industry has crossed the $2 trillion mark for assets under management (AUM).

As of June 30, 2015, $2.12 trillion was invested in exchange-traded funds and exchange-traded notes (ETNs). (We refer to both as ETFs unless specifically stated otherwise.) To put this number in perspective, just three years ago, AUM totaled $1.163 trillion. Yes, those numbers are correct: The dollars invested in U.S.-listed ETFs have nearly doubled since 2012.

With this growth has come more and more alternative index-based strategies. Among the 133 ETFs started during the first six months of 2015, over 20 have the word “hedge” in their name. Right near the end of June, iShares launched 11 currency hedged funds. These ETFs are intended to give investors exposure to the markets of foreign countries while smoothing out the impact of currency fluctuations.

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We’re also noticing a tendency for leveraged funds to become more specialized. This year, both Direxion and ProShares launched new ETFs targeting industries such as oil and gas and biotechnology. These new funds seek to return 300% of the daily move of the sectors they track.

Specialty strategies such as these are launched in response to perceived demand among institutional investors. Though they are available for purchase by individual investors, we don’t see a good reason to buy them. For example, an ETF designed to track a widely followed, broad international index has less risk and a lower expense ratio than a currency hedged Italian or Australian fund does.

The dollar amounts invested in the newer ETFs support our assumptions. Extending the time period to the last full 12 months, only 29 out of the 236 ETFs to have launched have in excess of $100 million in assets. In other words, the new specialty funds are not attracting broad audiences.

Nonetheless, the ETF industry continues to look to the fringes of index strategies to create new products to sell. Many of these strategies are being marketed or grouped under the “smart beta” (aka “strategic beta”) moniker. These are funds based on non-market-capitalization-weighted indexes. Whereas broad indexes, such as the S&P 500 index, assign the largest weightings to the company with the biggest market capitalization and the lowest weighting to the companies with the smallest market capitalization (called market-cap weighting), smart beta indexes may weight companies equally or weight them based on fundamental or price volatility factors.

It’s hard to properly assess how popular smart beta ETFs have become because there is no standard definition of what smart beta truly is. Plus, smart beta funds don’t have “smart beta” in their names. Rather, equity-based funds not using market-cap weighting are being grouped under the smart beta umbrella, rightly or wrongly. In early June, FactSet released a report saying that nearly half of ETFs currently on the market were smart beta. They estimated that these funds control 25% of the industry’s AUM.

What all of the above trends show is the continued difficulty ETF providers are having coming up with new ideas. The traditional index strategies (e.g. the S&P 500, the Russell 2000, etc.) have been fully exploited. We have seen fund families take advantage of many of the better-known return anomalies for stocks, including value, small-size, low beta, momentum and yield. We’ve also seen ETF providers establish firm footholds in the bond and commodities space. This is forcing ETF providers to come up with more and more exotic strategies to grab and/or maintain market share. It’s a trend we’ve pointed out previously and one we expect we will discuss in the future.

Some of these strategies may work. Others will flop, or at least not justify their higher expense ratios. We think investors would be wise to take the advice given by Warren Buffett in this year’s letter to Berkshire Hathaway shareholders: “Whatever their [bankers’] line, never forget that 2+2 will always equal 4. And when someone tells you how old-fashioned that math is—zip up your wallet.”

The Big Stay Big

Despite the introduction of new strategies, a significant portion of ETF assets still go to a relatively small number of funds and fund families. The 15 largest funds collectively control $0.33 out of every dollar invested in ETFs. The concentration increases as total assets rise. The five largest funds control $0.19 out of every dollar invested in ETFs. Eight cents out every ETF dollar is controlled by the largest fund, SPDR S&P 500 (SPY). The share of total ETF dollars going to the largest funds is trending slowly downward ($0.35 out every dollar went to the top 15 ETFs last year), but it remains very large, as Table 1 shows.

Table 1. The 15 Largest ETFs

ETF Name (Ticker)	Total Assets ($ Mil)	Expense Ratio (%)
SPDR S&P 500 ETF (SPY)	170,512	0.09
iShares Core S&P 500 (IVV)	67,702	0.07
iShares MSCI EAFE (EFA)	60,941	0.33
Vanguard Total Stock Market ETF (VTI)	56,152	0.05
Vanguard FTSE Emerging Markets ETF (VWO)	47,664	0.15
PowerShares QQQ ETF (QQQ)	38,792	0.20
Vanguard S&P 500 ETF (VOO)	32,282	0.05
iShares Russell 2000 (IWM)	29,690	0.20
iShares MSCI Emerging Markets (EEM)	29,584	0.68
iShares Russell 1000 Growth (IWF)	29,439	0.20
Vanguard FTSE Developed Markets ETF (VEA)	27,825	0.09
Vanguard Total Bond Market ETF (BND)	26,989	0.07
iShares Core S&P Mid-Cap (IJH)	26,915	0.12
SPDR Gold Shares (GLD)	26,774	0.40
iShares Russell 1000 Value (IWD)	25,922	0.20
Source: Morningstar, Inc. Data as of June 30, 2015.

Only one fund from last year’s Top 15 list failed to make this year’s list: Vanguard REIT Index ETF (VNQ). The fund is now the 17th largest ETF, ranked lower in part due to a 6.2% decline during the first half of 2015. Entering the Top 15 List this year is the Vanguard S&P 500 ETF (VOO). The fund’s AUM of $32.3 billion ranks it as the 7th largest ETF.

Notably, the Vanguard S&P 500 ETF and its two larger competitors—SPDR S&P 500 ETF (SPY) and iShares Core S&P 500 (IVV)—combined control nearly $0.13 out every ETF dollar. The statistic is skewed upward by the sheer size of the SPDR S&P 500, whose AUM of $170.5 billion is two and a half times the size of the second-largest ETF, the iShares Core S&P 500.

There also continues to be a large amount of market share controlled by a handful of fund families. BlackRock’s iShares unit oversees $810.8 billion of ETF assets. Vanguard and State Street Advisor’s SPDRs manage $470.1 billion and $409.7 billion, respectively. This equates to nearly 80% of all ETF dollars being invested in an iShares, a Vanguard or a SPDR fund.

Expense ratios were reduced on five of the largest 15 funds. The largest reduction occurred on the iShares Russell 2000 (IWM), which saw its expense ratio reduced by four basis points (0.04%) to 0.20%. IShares also lowered expenses on its Core S&P Mid-Cap (IJH), MSCI EAFE (EFA) and Russell 1000 Value (IWD) ETFs, by three, one and one basis points, respectively. Vanguard lowered the expense ratio on its Total Bond Market ETF (BND) by one basis point. The only large fund to pass along a fee increase was iShares MSCI Emerging Markets (EEM), whose expense ratio rose by one basis point to 0.68%.

Active ETFs Are Still Small

Actively managed ETFs remain a small niche of the ETF market. While PIMCO’s Enhanced Short Maturity Active (MINT) and Total Return Active (BOND) ETFs have very respectable AUMs of $3.5 billion and $2.5 billion, respectively, only one other actively managed ETF is above the $1 billion AUM threshold: First Trust North American Energy Infrastructure (EMLP). Conversely, 90 out of the 134 actively managed ETFs have AUM of less than $100 million.

A big part of the problem is transparency. ETFs are required to disclose their portfolio holdings every day. This isn’t an issue for a fund manager tracking an index, but it is a huge issue for a manager following an active strategy that he or she does not want revealed to competitors.

Hybrid solutions are being proposed. While one solution was rejected by the Securities and Exchange Commission (SEC), a coveted exemption from the federal law governing funds was granted. Eaton Vance’s NextShares is attempting to launch a series of exchange-traded managed funds (ETMFs). These funds would trade on an intraday basis, just like ETFs, but their net asset value would only be updated at the end of every trading day like a mutual fund. The transparency issue would be resolved by revealing the holdings less frequently than with an ETF. (A representative of NextShares said it is possible that holdings will be revealed every 30 days with a 30-day lag). A launch date remains uncertain.

Recently, industry website Ignites said that Vanguard is in talks with USAA about licensing its patented actively managed ETF platform. Vanguard has yet to launch an ETF version of its actively managed funds and there is no clear sign that it intends to do so in the foreseeable future.

For now, hopes for a large selection of active ETFs remain similar to hopes for a Chicago Cubs World Series victory, with fans cheering “wait until next year!”

New in This Year’s Guide

We added 15 additional funds to this year’s print guide, bringing the total to 461. The expanded spreadsheet contains a comprehensive spreadsheet of all 1,752 ETFs. (Last year, there were 1,613 ETFs and ETNs in existence.)

The categories are unchanged from last year. There are no new developments to justify altering the 56 categories previously used.

How to Use This Guide

Exchange-traded funds have lowered the cost and increased the accessibility of investing in a wide variety of securities, including large-cap stocks, emerging market debt, precious metals, currencies and even agricultural commodities. However, more choice does not necessarily equate to higher returns. Therefore, investors should tread carefully.

Financial goals, diversification needs and risk tolerances should be the primary determinants when selecting an exchange-traded fund. Specifically, ask what asset classes and categories need to be included in your portfolio and then look for ETFs that match those requirements. Asset allocation ideas can be found in the Financial Planning section of AAII.com. Our Model Fund Portfolio provides an idea of how to build and manage a diversified portfolio using a mix of mutual funds and exchange-traded funds as well as an alternative all-ETF portfolio. (We believe investors should compare both types of funds and use the one that provides the best exposure to a specific asset class or investment strategy.) The Model Fund Portfolio is reviewed in the March, May, August and November AAII Journal issues; the latest commentary is here. Monthly updates are available at AAII.com and via the free monthly AAII Model Portfolios Update email (sign-up at www.aaii.com/email).

Once asset class and category are determined, use this guide to find an appropriate exchange-traded fund. Most funds are named based on their underlying index (e.g., SPDR S&P 500 tracks the performance of the S&P 500 index). Understand that the construction of the underlying index will have a significant impact on the fund’s performance. For example, Apple Inc. (AAPL) has a far larger weighting in iShares Core S&P 500 Index ETF (IVV) than it does in Guggenheim S&P 500 Equal Weight (RSP). The bigger the weighting, the greater the influence on an ETF’s performance. The column in the guide labeled “percent of portfolio in top 10 holdings” shows how much weight is allotted to a fund’s largest positions.

All ETF sponsors list current holdings and the weighting of those holdings on their websites. This information not only provides additional insight into how dependent a fund is on its top two or three holdings, but it can also help improve an investor’s portfolio diversification. Pay particular attention to whether a specific company accounts for a large position in two or more funds you are interested in.

Expenses matter, and lower expenses are preferable. Expenses are influenced by the underlying securities; funds that use foreign securities, invest in commodities, or use aggressive long or short strategies carry higher expenses. Some brokers waive commissions on select ETFs, but the savings on the commissions need to be weighed against the annual expense ratio and the suitability of the ETF. In other words, selecting an exchange-traded fund solely because commissions are waived may actually turn out to be a more expensive decision.

Again, be sure to look at a list of the fund’s current holdings and read through the prospectus before buying any exchange-traded fund. A listing of ETF sponsor websites is included in the expanded spreadsheet.

Which Funds Were Included

The funds listed in the print version largely have at least $400 million in total assets. The rule was relaxed for funds held within the Model Fund Portfolio, which is why you will see Guggenheim S&P MidCap 400 Pure Value (RFV) and Guggenheim S&P SmallCap 600 Pure Value (RZV) in the print guide. We also relaxed the rule for categories of general interest whose funds are not large enough to have qualified for the AUM rule.

Funds included in the guide must be in existence for at least six months. The time requirement is used to limit the number of funds listed in the print version of this guide for space reasons, while still allowing newer funds with sizeable amounts of total assets to be included.

A comprehensive listing of ETFs and ETNs with performance data and additional information is available in the expanded spreadsheet. It includes funds of all sizes and covers all 1,752 ETFs and ETNs.

Ultra and Contra ETFs

For members following aggressive trading strategies, ultra market (long) and contra stock market are two of the categories included in this guide. The ultra category includes funds that are designed to move in the same direction as their underlying index but to experience two to three times the price movement. The contra categories (stock, bond and commodity) contain funds that are designed to move in the opposite direction as the underlying index. Some of these funds may experience inverse price movements that are two to three times greater than those of the underlying index.

Funds that move with a greater magnitude than the index they track use leverage. For every dollar invested, an investor has the potential to earn double or triple the return he or she would otherwise earn. At the same time, the magnitude of potential losses is two to three times greater. In other words, these are very risky investments.

In addition to the considerably higher level of volatility, these funds have a much greater potential for tracking error. Tracking error is the extent to which a fund’s net asset value (NAV) return differs from the underlying index’s return. (Tracking error can also occur if an ETF’s market return is different than its NAV return. All index funds face tracking error to some extent.) Tracking error can result in actual returns being significantly different from what an investor anticipated based on the performance of an index. ProShares, one of the providers of ultra and contra funds, clearly warns investors not to hold such funds for longer than one day. Specifically, ProShares states, “Due to the compounding of daily returns, ProShares’ returns over periods other than one day will likely differ in amount and possibly direction from the target return for the same period.”

This warning applies to both ultra and contra funds. These ETFs are suitable only for speculative trading for the time period listed in the prospectus (typically a single day); they should not be used for a longer-term holding.

Investors concerned about market risk will be better served by maintaining proper diversification across asset classes, staying focused on long-term financial goals and conducting a thorough analysis of all investments.

A Key to Terms and Statistics

Most of the information shown in the listing is provided by Morningstar Inc. or is calculated from the data the company provided. Any data source has the potential for error, however. Before investing in any exchange-traded fund or exchange-traded note, you should read the prospectus, annual report and quarterly reports.

When a dash appears in an ETF listing, it indicates that the number was not available or does not apply in that particular instance. For example, the three-year annual return figure would not be available for funds that have been operating for less than three years. We did not compile bull and bear ratings for ETFs not operating during the entire bull or bear market period.

Return numbers that are in the top 25% of all funds within the investment category are shown in boldface. When the risk is in the lowest 25% for the category, this number is also bolded.

Figures given for the category averages are calculated based on the entire universe of ETFs. The averages may be skewed by ETFs only included in the online version of this guide.

The following provides an explanation of the terms we use in the ETF listings. The explanations are listed in the order in which the data and information appear in the listing.

Index Fund: The letter “I” before a fund’s name indicates that the fund is designed to mimic the performance of an index, such as the S&P 500; the amounts invested in each security are proportional to its representation in the index that the fund tracks. (Some funds may hold fewer securities than the actual index if they believe the same return characteristics can still be achieved.) The expanded spreadsheet reports on the indexes tracked by these funds. In some cases, an index has been specifically created for the fund and may have different return characteristics than other indexes with similar names.

Enhanced: The letter “E” before a name indicates that the fund is designed to outperform its underlying index by improved security selection or following a strategy that reduces comparative volatility.

Exchange-Traded Note (ETN): The letter “N” before a fund’s name indicates that the investment is an exchange-traded note. An ETN is a debt security designed to mimic the performance of an underlying index. The credit quality of the issuer needs to be considered when researching an ETN.

ETF Name: The exchange-traded funds are presented alphabetically by name within each category.

Ticker: The ticker symbol for each exchange-traded fund is given in parentheses for those investors who may want to access data online or through a touch-tone phone.

Total Return (%): Returns are based upon changes to a fund’s net asset value (NAV) or, where designated, share price (market return), assuming the reinvestment of all income and capital gains distributions (on the actual reinvestment date used by the fund) during the period. The return calculation is net of expenses. The year-to-date, 12-month, three-year and five-year returns are calculated through June 30, 2015. The three- and five-year returns are presented on an annualized basis. Returns that are in the top 25% of all ETFs within the investment category are shown in boldface.

Bull Market Return: Reflects the ETF’s net asset value total return in the most recent bull market, starting March 1, 2009, and continuing through June 30, 2015. Returns in the top 25% of all ETFs within the investment category are shown in boldface.

Bear Market Return: Reflects the ETF’s net asset value total return in the most recent bear market, from November 1, 2007, through February 28, 2009. Returns in the top 25% of all ETFs within the investment category are shown in boldface.

Yield (%): The total annual income distributed by the ETF divided by the period-ending net asset value. Calculated on a per share basis, this ratio is similar to a dividend yield and would be higher for income-oriented funds and lower for growth-oriented funds. The figure only reflects income; it is not a total return.

Tax-Cost Ratio (%): Measures how much an ETF’s annualized return is reduced by the taxes paid on distributions, assuming the maximum marginal tax rate. A tax-cost ratio of 0.0% indicates that the fund did not make any taxable distributions. If a fund had a 3.0% tax-cost ratio, it means that on average each year, investors lost 3.0% of their assets to taxes. The lower the ratio, the more tax-efficient the ETF. The ratio is calculated using the last three years of data.

Risk Index—Category and Total: The category risk index is the standard deviation of an ETF’s return divided by the standard deviation of return for the average ETF in the category. The total risk index is the standard deviation of an ETF’s return divided by the average standard deviation of return for all funds. Standard deviation is a measure of return volatility and is computed using monthly returns for the last three years. A risk index of 1.00 denotes average risk. Values above 1.00 indicate greater risk than average while values below 1.00 indicate less risk than average. Risk numbers that are in the lowest 25% of all funds within the investment category are shown in boldface.

Total Assets ($ Mil): Presented as millions of dollars, this is the amount of total assets an exchange-traded fund has under management (AUM). This is the total value of the fund’s portfolio. Size can be affected by the age of the fund, the index it follows and the number of competitive funds.

Average Daily Trading Volume (Thousands): Average daily volume of shares traded for the last three-month period through June 30, 2015.

Portfolio (%)—Stocks: The percentage of assets held in common stocks, both domestic and foreign. Bonds: The percentage of assets held in debt securities that are not convertible into common stock. Other securities: The percentage of assets held in futures, options, preferred stock, trusts or other alternative securities. Cash: The percentage of assets held in cash or cash equivalents.

Percent of Portfolio in Foreign Issues: The percentage of the ETF’s assets that are invested in foreign stocks and foreign bonds.

Portfolio Turnover Ratio (%): A measure of the trading activity of the ETF, which is computed by dividing the lesser of purchases or sales for the year by the monthly average value of the securities owned by the fund during the year. Securities with maturities of less than one year are excluded from the calculation. The result is expressed as a percentage, with 100% implying a complete turnover within one year.

Number of Holdings: The total number of individual securities held by the ETF. These can include stocks, bonds, currencies, futures contracts and option contracts. This figure is meant to be a measure of portfolio risk: The lower the number, the more concentrated the fund is in a few issues. Some ETFs may hold fewer shares than the index’s name would suggest if the ETF’s manager believes he can mimic the returns of the index without holding all of the securities in it.

Percent of Portfolio in Top 10 Holdings: Investments, expressed as a percentage of the total portfolio assets, in the ETF’s top 10 portfolio holdings. The higher the percentage, the more concentrated the fund is in a few companies or issues, and the more the fund is susceptible to market fluctuations in those few holdings. Used in combination with the number of holdings, this figure can indicate how concentrated an ETF is.

Expense Ratio (%): The sum of administrative fees and adviser management fees divided by the average net asset value of the ETF, stated as a percentage. Brokerage costs incurred by the fund are not included in the expense ratio, neither are the commissions you may pay to buy and sell shares.

Category Definitions: Click here to download descriptions of the ETF categories used in this guide.

More on ETFs

An Inside Look at Exchange-Traded Funds

ETFs and ETNs: Knowing What You Own

Active Funds and Other Changes in the ETF Industry

Using ETFs in a Tough, Sideways-to-Bear Market

Building & Managing Your Portfolio

How to Safely Navigate Through Crowded ETF Waters

The EZ Approach to ETF Portfolio Building

Nine Timeless Rules for Investing in Mutual Funds (and ETFs)

Further Research on ETFs

Visit Computerized Investing’s “Best of the Web” sections on ETFs:

Best Sites for Mutual Fund & ETF Data

Best Sites for Mutual Fund & ETF Ratings & Recommendations

Best Sites for Mutual Fund & ETF Screeners

ETF & ETN Contact Information