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Avoid Wisdom of Crowds When Picking ETFs

The Wall Street Journal recently ran a series of articles contending that most investors could achieve better returns using Exchange-Traded-Funds (ETFs) to track market indexes than by picking individual stocks.

Thats probably so, but you could substantially outperform most ETF investors by avoiding the most popular ETFs. Here are the details.

Overall Market

The S&P 500 index, which tracks 500 large-capitalization stocks (largest companies in terms of value of shares outstanding), is, arguably, the most widely watched market gauge. Thus, it figures that the SPDR S&P 500 ETF (SPY), which tracks that index, is the most popular ETF, trading more than 100 million shares daily.

The last time I checked, the S&P 500 fund had returned 5.4% over the past year, 9.0%, on average, annually, over the past three years, and 14.1% over five years.

However, large-cap investors would have done better using the lesser-known iShares Morningstar Large-Cap ETF (JKD), which tracks an index of 75 U.S.-based large-cap stocks. This fund, which trades only 15,000 shares daily, returned 8.5% over the past year, 9.5%, on average, annually, over the past three years, and 15.5% annually over five years.

Small Cap Stocks

Stock prices typically track earnings growth and small-cap stocks often offer faster earnings growth potential than larger, more established firms. The iShares Russell 2000 ETF (IWM), which tracks the Russell index of 2000 small-cap stocks, trading 31 million shares daily, is the clear choice for most small-cap investors. How have they fared? Not bad, but nothing to write home about either.

The fund returned 6.0% over the past 12-months, and 4.3% and 12.9%, on average, annually, over the past three and five years, respectively. But consider the WisdomTree Small-Cap Dividend Fund (DES) that tracks an index of more than 600 U.S.-based dividend paying small-caps. This fund, trading less than 100,000 shares daily, returned 12.0% over 12-months, and 6.3% and 14.3%, on average, annually, over three and five years.

Technology

When it comes to growth, technology is where its at, and for tech, most investors turn to the PowerShares QQQ (QQQ). It tracks the Nasdaq-100 Index of the 100 largest non-financial stocks trading on the Nasdaq. The QQQ, which trades 29 million shares daily, is no slouch, having returned 6.9% over 12-months, and 14.3% and 17.2%, on average, annually, over three and five years.

Compare those returns to the First Trust NASDAQ 100 Tech Sector ETF (QTEC), which tracks only 36 mostly U.S.-based tech stocks, and trades less than 50,000 shares daily. This fund has come on strong recently, returning 18.0% over the past year, and 17.2%, on average, annually, over the past three years. Its five-year annual returns totaled 16.8%, slightly short of the QQQs 17.2% number.

In the Chips  

Finally, if youre looking for another hot tech sector, check out the PowerShares Dynamic Semiconductors Portfolio (PSI), which tracks 30 U.S.-based semiconductor stocks. This fund, which trades only 22,000 shares daily, has returned 26.3% over the past 12-months and 124.3% and 19.1%, on average, annually, over the past three and five years.

As usual, past performance doesnt predict the future. Watch the news and sell funds when their industry sector is moving out of favor.

published 11/2/16

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