Article Highlights:

• This year’s expanded guide contains return, expense and portfolio information on more than 540 ETFs, ETNs and related exchange-traded funds.
  
• The cost of investing in ETFs continues to come down. Expense ratios have been lowered further, while Vanguard is waiving commissions on nearly 1,800 ETFs.
  
• The ETF industry continues to grow, though on a percentage basis the rate of growth has slowed.
  

Exchange-traded fund (ETF) assets under management (AUM) expanded 18.5% on a year-over-year basis.

Total assets under management for U.S.-listed ETFs was roughly $3.5 trillion, up from $2.9 trillion 12 months ago. (We include ETNs and other exchange-traded products in the umbrella term ETFs in this article, unless specifically stated otherwise.) AUM for ETFs can grow year over year, even when investors sell shares, if returns are positive.

The strong growth of the ETF market has been attributed to investors’ desire to move more money into passively managed assets, a greater focus on lower-fee funds and the ease of buying and selling that these funds offer. However, growth is slowing: In last year’s guide, we reported that ETF assets grew 30% year over year. If you look at dollar terms, as opposed to percentage change, ETF assets increased by $720 billion from June 2016 to June 2017, and $552 billion from June 2017 to June 2018. While AUM for ETFs is continuing to experience strong growth, the total amount invested in ETFs remains only a fraction of what is invested in mutual funds. According to the Investment Company Institute, through May 2018, mutual fund assets under management totaled roughly $18.9 trillion.

AUM for active ETFs grew by a larger percentage than that for passive ETFs. Passive ETFs track an index in an attempt to match the index’s return (although passive funds usually return slightly less than the index itself because of fees). Active ETFs do not track an index; rather, they rely on the skills of a portfolio manager and tend to have higher fees (expense ratios) than passive funds.

Since June 2017, active ETF assets grew 54.2%, while passive assets grew 18.1%. The percentage growth rate is influenced by the fact that active funds started with a smaller base—in May 2017, active funds had roughly $40 billion in AUM versus $2.9 trillion for passive funds. As of June 30, 2018, passive assets totaled $3.5 trillion, while active assets totaled $58.6 billion. The number of active ETFs grew 28.9% since last year’s guide, while the number of passive ETFs grew 3.4%, but again, the actual change (not percentage change) was relatively close: There are an additional 58 net new active funds covered in the online version of this year’s guide and 62 additional passive funds. This means that, although there are many more passive funds in existence with a significantly larger amount of AUM, fund sponsors are also perceiving interest in active ETFs. Before active ETFs existed, individual investors would have to rely on mutual funds as an active management vehicle.

Shrinking Expenses

Another notable trend in the ETF industry is shrinking expense ratios. Data from Morningstar shows that ETF fees have fallen 30% over the past 10 years. Expense ratios reduce the return received, and studies have shown that ETFs with higher expense ratios underperform their peers (this is not always the case). BlackRock, the largest ETF provider, cut fees on several stock and bond ETFs in June. Last fall, State Street Corp. introduced what it marketed as a new lineup of low-cost ETFs, although the ETFs were “rebranded” from already existing ETFs (the ETF’s name, ticker and expense ratio simply changed on many of these ETFs). State Street also inked a deal to be the sole provider of commission-free ETFs on TD Ameritrade’s brokerage platform.

Vanguard recently announced commission-free online transactions for the majority of ETFs available. The program excludes “highly speculative” and “complex” ETFs. Vanguard’s move is unique; traditionally the industry has followed a “pay to play” model where ETF providers pay to be included in a broker’s commission-free lineup. Vanguard did not require fees from providers.

While cutting fees is good for investors and increases an issuer’s market share, it may hurt ETFs and brokerage firms if ETF growth stalls.

ETFs Versus Mutual Funds

When an investor takes a position in an ETF, they are exchanging shares with other investors through an exchange (much like stocks). ETF managers accommodate investment inflows and outflows by creating or redeeming “creation units,” which are baskets of assets that approximate the entirety of the ETF’s holdings. With a mutual fund, on the other hand, you are buying or redeeming shares directly with the fund at the end-of-day net asset value (NAV). There is no limit to the number of shares issued (in the case of “open-ended” mutual funds). Mutual fund managers may be forced, at times of high redemptions, to sell securities to accommodate shareholder redemptions, which creates a taxable event for all shareholders.

It’s worth noting that mutual funds are generally more suitable than ETFs when an investor is looking to repeat specific transactions automatically (like an auto-deposit). But brokers offering commission-free ETF trading, such as Vanguard recently announced, may change this preference.

Commissions aside, ETFs tend to be more favorable in a taxable brokerage account. When a mutual fund manager sells a security with a gain, a taxable event is created for all mutual fund shareholders—even for shareholders who may have a realized loss in the fund overall. This is not the case with ETFs: Investors are not affected (regarding taxes) when other investors or the fund managers buy and sell securities. This may be different for certain categories of ETFs (depending on the assets held). ETFs tend to be more tax efficient but are not tax free. Distributions are taxable, as are realized capital gains on the funds. The strategy used and the assets invested play a role—for example, emerging markets may have to sell securities to raise cash for redemptions instead of delivering stock, which would create a taxable event for investors.

Investors should compare both types of funds and use the one that provides the best exposure to a specific asset class or investment strategy.

How to Use This Guide

Exchange-traded funds provide a low-cost and accessible way 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 with higher returns. Therefore, investors should tread carefully.

Financial goals, diversification needs and risk tolerances should be the primary determinants when selecting an ETF. Specifically, decide which asset classes and categories need to be included in your portfolio and then look for ETFs that match those requirements. Research has shown that asset allocation decisions explain over 90% of the variance in portfolio returns. Asset allocation ideas can be found in the Financial Planning section of AAII.com.

Once a desired asset class and category are determined, use this guide to help find an appropriate exchange-traded fund. Most funds are named based on their underlying index [e.g., SPDR S&P 500 ETF (SPY) 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, a large company such as Apple Inc. (AAPL) has a far larger weighting in the iShares Core S&P 500 Index ETF (IVV), which weights stocks by capitalization, than it does in Invesco S&P 500 Equal Weight ETF (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. A higher percentage means the ETF is more dependent on the performance of a smaller number of ETF securities or portfolio holdings.

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 on its top two or three holdings a fund is, 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 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 or otherwise incorrect decision.

As we recommend in the Mutual Fund Guide: Don’t chase performance. Just because an ETF is the best performer in its category over the last year doesn’t mean it will continue this performance in the future. If, on the other hand, an ETF you hold continually lags its category average, it may be time to search for a replacement.

Which Funds Were Included

This year’s print guide contains a record 543 funds. The online version of this guide includes all 2,162 ETFs listed on the U.S. exchanges. (Last year, there were 2,042 U.S.-listed ETFs and ETNs in existence.)

With a limited number of exceptions, the funds listed here largely have at least $450 million in total assets. As with stocks, limited investor interest (or low AUM) can translate into poor liquidity. Low liquidity can mean that you will not be able to sell easily when the time comes. However, Invesco Russell 1000 Equal Weight (EQAL) is listed in this guide due to its inclusion in AAII founder James Cloonan’s Level3 Passive Portfolio. Read Jim’s book, “Investing at Level3” to learn more about the rationale for allocating to this fund. Table 1 shows the current list of the 15 largest ETFs measured by assets under management, along with their expense ratios.

Table 1. The 15 Largest ETFs
ETF Name (Ticker)	Total Assets ($ Mil)	Expense Ratio (%)
SPDR S&P 500 ETF (SPY)	259,300	0.09
iShares Core S&P 500 ETF (IVV)	148,272	0.04
Vanguard Total Stock Market ETF (VTI)	97,478	0.04
Vanguard S&P 500 ETF (VOO)	90,594	0.04
iShares MSCI EAFE ETF (EFA)	72,573	0.32
Vanguard FTSE Developed Markets ETF (VEA)	70,015	0.07
Invesco QQQ Trust (QQQ)	65,895	0.20
Vanguard FTSE Emerging Markets ETF (VWO)	60,483	0.14
iShares Core MSCI EAFE ETF (IEFA)	57,502	0.08
iShares Core US Aggregate Bond ETF (AGG)	55,285	0.05
iShares Core S&P Mid-Cap ETF (IJH)	47,209	0.07
iShares Russell 2000 ETF (IWM)	47,045	0.20
iShares Core MSCI Emerging Markets ETF (IEMG)	46,713	0.14
iShares Core S&P Small-Cap ETF (IJR)	42,937	0.07
iShares Russell 1000 Growth ETF (IWF)	42,270	0.20
Source: Morningstar, Inc. Data as of June 30, 2018.

Funds included here also must have been in existence for at least a year. The time requirement is used in the print version of this guide for space reasons, while still allowing newer funds with sizeable amounts of total assets to be included.

There are several category changes this year. Six new categories have been added: energy limited partnership, Canada/Mexico foreign stock, Middle East/Africa foreign stock, ultra bond, high yield international bond and contra international bond. Of the 60 total categories, five do not appear in the print ETF listing because of the page restriction for our print version: the contra commodities, foreign contra stock, ultra bond, international high yield bond and contra international bond categories had no ETFs with over $450 million in assets.

Comprehensive listings of ETFs and ETNs with performance data and additional information are available on AAII.com at www.aaii.com/etf-guide. The expanded and interactive online tables and downloadable spreadsheet include funds of all sizes and cover all 2,162 ETFs and ETNs.

Ultra and Contra ETFs

For members following aggressive trading strategies, ultra market (long) and contra 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 experience two to three times the price movement. The contra categories (stock, bond and commodity) are made up of funds that are designed to move in the opposite direction as the underlying index, with inverse price movement up to three times greater.

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 they would otherwise earn. At the same time, the magnitude of potential losses is also 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 NAV return differs from the underlying index’s return. Leveraged ETFs are more prone to tracking error because of the manner in which their returns are compounded. The compounding process results in a reduction of realized leverage the longer an investor holds such funds, and most leveraged ETFs are designed to be held for only one day. Those desiring more information about how the performance of these funds is affected over time should read “Leveraged ETFs: Multiplying by the Unknown” by William J. Trainor Jr. in the July 2017 AAII Journal.

When the market direction favors a leveraged ETF—an upward-trending market for ultra ETFs and a downward-trending market for inverse ETFs—the returns can be appealing; however, it is extremely important to realize that leveraged funds can destroy wealth as quickly as they create it.

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 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 and expense ratio 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 not included here in the print version of this guide.

The following provides an explanation of the terms used in the print guide. The explanations are listed in the order in which the data and information appear in the guide.

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 online version of this guide names 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.

Structure: The letters “OE” indicate that the ETF is an open-ended investment company. “OE” includes exchange-traded funds, exchange-traded managed funds (ETMFs) and mirror open-ended funds as they report NAV returns.

The letters “DU” stand for uncollateralized debt instrument, which is an exchange-traded note. As a debt security, ETNs do not generate the return of their index via underlying securities, but the ETN issuer guarantees the holder the return of the underlying index (minus expenses).

The letters “UIT” stand for unit investment trust. A unit investment trust is a registered investment company that buys and holds a generally fixed portfolio of stocks, bonds or other securities. “Units” in the trust are sold to investors (unitholders) who receive a share of principal and dividends (or interest). A UIT has a stated date for termination that varies according to the investments held in its portfolio.

The letter “P” stands for partnership. ETFs as partnerships are a commodity pool structure and track oil, commodities or currencies.

The letters “GT” stand for grantor trust. Indicated in the taxation portion of the prospectus, the trust will consist of a set “basket” and they have fixed portfolios. 

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, 2018. 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 January 31, 2018. The bull market return period was held steady because of the mixed performance during the period of February through June 2018. 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, not 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 2.0% tax-cost ratio, it means that on average each year, investors lost 2.0% 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, 2018.

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: 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 they 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. Expense ratios that are in the lowest 25% of all funds within the investment category are shown in boldface.

More on ETFs

The Four Groups of ETFs

Why Aren’t There More Active ETFs?

Leveraged ETFs: Multiplying by the Unknown

An Inside Look at Exchange-Traded Funds

ETFs and ETNs: Knowing What You Own

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

Building & Managing Your Portfolio

Tracking the S&P 500 With Mutual Funds and ETFs

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

AAII staff John Bajkowski and Charles Rotblut, CFA, also contributed to this guide.

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