How To Find The Best Sector ETFs

By David Trainer and Kyle Guske II of New Contstructs
Date: Wednesday, April 30, 2014 12:53 PM EST

Finding the best ETFs is an increasingly difficult task in a world with so many to choose from.

You Cannot Trust ETF Labels

There are at least 45 different Financial ETFs and at least 181 ETFs across all sectors. Do investors need that many choices? How different can the ETFs be?

Those 45 Financial ETFs are very different. With anywhere from 19 to 549 holdings, many of these Financial ETFs have drastically different portfolios, creating drastically different investment implications.

The same is true for the ETFs in any other sector, as each offers a very different mix of good and bad stocks. Some sectors have lots of good stocks and offer quality funds. The opposite is true for some sectors, while others lie in between these extremes with a fair mix of good and bad stocks. For example, the Financial sector, per my 2Q Sector Rankings Report ranks ninth out of 10 sectors when it comes to providing investors with quality ETFs. Consumer Staples ranks first. Utilities ranks last. Details on the Best & Worst ETFs in each sector are here

The bottom line is: ETF labels do not tell you the kind of stocks you are getting in any given ETF.

Paralysis By Analysis

I firmly believe ETFs for a given sector should not all be that different. I think the large number of Financial (or any other) sector of ETFs hurts investors more than it helps because too many options can be paralyzing. It is simply not possible for the majority of investors to properly assess the quality of so many ETFs. Analyzing ETFs, done with the proper diligence, is far more difficult than analyzing stocks because it means analyzing all the stocks within each ETF. As stated above, that can be as many as 549 stocks, and sometimes even more, for one ETF.

Any investor worth his salt recognizes that analyzing the holdings of an ETF is critical to finding the best ETF.

Figure 1: Best Sector ETFs

Screen shot 2014-04-30 at 8.26.58 AMSources:   New Constructs, LLC and company filings

The Danger Within

Why do investors need to know the holdings of ETFs before they buy? They need to know to be sure they do not buy a fund that might blow up. Buying a fund without analyzing its holdings is like buying a stock without analyzing its business and finances. As Barron’s says, investors should know the Danger Within. No matter how cheap, if it holds bad stocks, the ETF’s performance will be bad.

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David Trainer and Kyle Guske II receive no compensation to write about any specific stock, sector, style or theme.

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