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The Best and Worst New ETFs of 2016

Among the many new launches, there were plenty of lumps of coal and a few diamonds to be found.

Ben Johnson, 12/28/2016

A version of this article was published in the October 2016 issue of Morningstar ETFInvestor. Download a complimentary copy of ETFInvestor here

As of Dec. 6, there were 220 new exchange-traded products (inclusive of exchange-traded funds and exchange-traded notes) launched in the U.S. market in 2016. This places 2016 fourth behind 2007, 2015, and 2011 in terms of total number of new ETP launches in a given calendar year. There are now a total of 1,957 ETPs available to investors. Since SPDR S&P 500 ETF SPY was launched in 1993, 2,531 ETPs have been brought to market. This means that nearly 23% of them have since been closed.

Though there are plenty of choices on the ever-expanding menu, investors' tastes are fairly basic. Of the 1,957 ETPs on offer, the top 100 as measured by assets under management accounted for 74% of the $2.5 trillion invested in ETPs at the end of November. What does this mean for investors? First, it means that the best options are already out there and have been for some time, right in front of your nose. Second, it means that the odds of something better coming to market grow slimmer with time. It's going to be awfully difficult to beat access to the entire U.S. stock market at a cost of 0.03% per year or the U.S. investment-grade bond universe for 0.04%.

Here, I take a look at the class of 2016 and call out what I believe are the best and worst new launches of the year.

The Best 
It is difficult to stand out in this cramped landscape. If anything, standing out can be detrimental, as the traits of successful new entrants are no different than those of existing best-of-breed funds: broad-based asset-class exposure, low fees, a solid sponsor, and--ideally--early signs of long-run viability (I want to make sure these funds will be around three, five, and 10 years from now).

Vanguard International Dividend Appreciation ETF VIGI 
VIGI is the foreign cousin of Vanguard Dividend Appreciation ETF VIG, which has a Morningstar Analyst Rating of Gold. Like its U.S. relative, the fund boasts a low fee, a sensible process, and a solid parent. At 0.25%, VIGI's price tag is well below the median levy of 0.47% taken by its ETF peers (which I've defined as foreign-equity funds that have been tagged with our "Dividend Screened/Weighted" strategic-beta attribute). This is also a fraction of the 1.14% median toll taken by members of the foreign large-blend Morningstar Category. As is the case with VIG, the fund's underlying index--the Nasdaq International Dividend Achievers Select Index--looks to home in on stocks that have a long history of paying and growing their dividends. As is also the case with VIG's index, the methodology document for this fund's bogy is lacking detail. What we know for sure is that in both cases, the result of the process defined by the indexes' guiding principles is a portfolio of high-quality stocks. As of the end of October, the stocks in VIGI's portfolio had an average return on invested capital of 13.62%, versus 10.44% for the average fund in its category. Additionally, 80.2% of VIGI's portfolio was invested in stocks that our analysts deem to have wide or narrow Morningstar Economic Moat Ratings, versus 69.6% for its average peer. Economic moats are evidence of a high-quality firm with sustainable competitive advantages.

All told, I think that VIGI is the valedictorian of the ETF class of 2016. The fund is a compelling option for investors looking for a low-cost, diversified source of dividend income from overseas markets.

NuShares Enhanced Yield U.S. Aggregate Bond ETF NUAG 
NUAG is the first ETF from fixed-income stalwart Nuveen. The fund joins a growing roster of strategic-beta fixed-income ETFs that are looking to deliver something more than what investors might get from a more traditional, market-capitalization-weighted bond index. For its part, NUAG tries to juice the yield of a broad-based bond index while maintaining a similar level of risk. In its very short life--the fund was launched in September--it has succeeded in both regards. That said, it's still early, and competition in the space is stiff. There are dozens of Morningstar Medalists in the intermediate-term bond category and more-vanilla passive peers are available at a fraction of the cost. Still, for those looking for just a little more than what they might get from a purely passive expo­sure and something that will also be a little more reliable (given that it tracks an index), NUAG is worth keeping an eye on.

The Worst
There were plenty of suspect new entrants into the ETP space in 2016. A common thread among them is that they're preying on investors' impulse to chase what's hot. These funds tend to offer narrow and often overly complex exposures, charge high fees, and have sponsors that prioritize salability over staying power.

VelocityShares 3x Long Crude Oil ETN UWT and VelocityShares 3x Inverse Crude Oil ETN DWT 
These exchange-traded notes were launched to replace their predecessors VelocityShares 3x Long Crude Oil ETN UWTI and VelocityShares 3x Inverse Crude Oil ETN DWTI, which were delisted (not liquidated) as of the close of trading on Dec. 8. Credit Suisse, the bank that had backed UWTI and DWTI, presumably pulled out of its arrangement with VelocityShares (as was its right) and left investors holding the bag. The predecessor notes now trade over the counter, and those that didn't sell prior to their delisting will now have to pay a pretty penny to unload their shares, as they are highly illiquid and trade at a discount to their net asset value. So in come UWT and DWT (ProShares and U.S. Commodity Funds were also quick to submit opportunistic filings for competing offerings) to fill the void left in the wake of UWTI and DWTI's demise. But all of this is beside the point. Who needs to get exposure to 3 times the daily price movements in an oil index anyway?

Spirited Funds/ETFMG Whiskey & Spirits ETF WSKY 
There were a host of thematic ETFs that were launched in 2016, covering a wide variety of trending topics (3-D printing, the obesity epidemic, video game technology, you name it). This made it difficult to pick just one for my short list of 2016's worst. At the end of the day, none is more concentrated or more costly than WSKY. This fund has 79% of its portfolio invested in its top 10 holdings, with top holding Diageo DEO alone soaking up nearly 23% of its assets. The fund charges an annual fee of 0.75%, a hefty price to pay for a concentrated bet on booze. Investors would be well-served to leave this one on the shelf.

  

Disclosure: Morningstar, Inc. licenses indexes to financial institutions as the tracking indexes for investable products, such as exchange-traded funds, sponsored by the financial institution. The license fee for such use is paid by the sponsoring financial institution based mainly on the total assets of the investable product. Please click here for a list of investable products that track or have tracked a Morningstar index. Neither Morningstar, Inc. nor its investment management division markets, sells, or makes any representations regarding the advisability of investing in any investable product that tracks a Morningstar index.

 

Ben Johnson is Morningstar’s Director of European ETF Research.

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