Decisions, Decisions: How Does One Pick an ETF?

You really know how to pick ’em.

There are roughly 5,500 ETFs from about 500 issuers listed in the US. Yet for the bulk of their allocations, advisors tend to stick with broad-market index funds from mega-managers like BlackRock, Vanguard and State Street, which collectively hold more than 70% of all ETF assets, per ETFGI data. But when advisors venture beyond the biggest and most established funds — seeking out higher returns, tax benefits or lower correlation to the stock market — how do they decide which ETFs deserve a closer look?

Sometimes, a simple rule is all that’s needed. 

“If I can’t explain why it exists, I don’t own it,” said Aaron Gaines, founder of Gaines Capital Management. “I’m not looking for the hottest ticker or the best-looking three-year return.” Upon initially considering a fund, Gaines said he focuses on liquidity, reasonable assets under management, competitive fees and an issuer with a track record of operating funds responsibly. “I generally prefer ETFs that have survived a real market cycle, but I won’t reject a newer fund simply because it’s new.”

Live Fast, Die Young

There are plenty of novel ETFs hitting or about to hit the market, including funds focused on 3x leverage, weather predictions and sports team performances. It can all feel a bit out there, but also kind of enticing. Generally speaking, advisors are more thoughtful investors than the average client, but they aren’t immune to FOMO.

“Advisors feel the same pull clients do,” said Matthew Chancey, founder of Tax Alpha Companies. If a thematic fund launches the same month a trend hits the news, Chancey sees that as an immediate red flag. “New funds are being built faster than they’re being bought,” he told Advisor Upside. “New feels like an edge, [but] usually, it’s just new.” He looks for at least a little longevity before choosing an ETF. “Let it earn its second birthday before it earns your client’s money.”

Brevity has become a hallmark of many ETFs lately:

• Last year, more than 1,100 ETFs launched in the US, a new record, according to Morningstar.
• However, 221 ETFs closed, and among the roughly 150 active funds that shuttered, the average lifespan was less than two years on the market.

KISS. For some advisors, that short life cycle is another reason to keep things simple. “The biggest mistake I see is chasing a hot theme in a thin, expensive fund,” said John Bell, founder of Free State Financial Planning. “Boring, cheap and liquid usually wins.”