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By Scott Burns | 07-23-2010 11:32 AM

Five Overlooked 5-Star ETFs

Morningstar's Scott Burns and Paul Justice examine five standout large-cap ETFs.

Scott Burns: 5-Star ETFs that investors are overlooking. Hi, there. I'm Scott Burns with Morningstar. Joining me today is Paul Justice, our Director of North American ETF Research.

Paul, thanks for joining me.

Paul Justice: Pleasure.

Burns: So I think, the first thing on viewers' minds is a 5-Star ETF, isn't that a bit inconsistent, how can an ETF be 5-stars, isn't it just an index?

Justice: Well, for the most part ETFs are index funds. But an index can go far beyond just market cap weighting. Most ETF insiders know this already that there is wide swath of opportunities, equal-weighted, market cap-weighted, fundamentally-weighted, some of them driving up from quantitative factors. And what we've seen is a great deal of outperformance by a lot of these quantitative ETFs, the ETFs that are applying additional screening besides the most basic aspects of stock investing.

Burns: What are some examples of those screens?

Justice: Well, before I get into it too much, I'd like to say what we're really looking for. So there are several 5-Star ETFs on the market, and we compare them against the whole open end mutual fund world. What we decided to do was, make sure that we're looking at it by asset class to start with, and we picked out five large cap ETFs that have achieved 5-Star ratings and the reason being is, we've seen so much market commentary from very well-know investors talking about how large cap stocks right now are presenting a compelling value.

Bill Miller, for instance, has come out and said that large caps look like the opportunity of a lifetime right now. We've also seen commentary from folks like Jack Bogle and Longleaf Partners talking about how equities are relatively cheap compared to bonds these days. Even Jeremy Grantham is looking kind of in the high quality space of the equity world to find better returns over the next several years. So, when we went into our screens we looked at the large cap space based on that, identifying that – the segment of the market that we wanted to hit, and then sort it out by the performance against the peers.

Burns: So, when we look in this large cap space, we do have a couple standouts. So, what are the funds from top to bottom in terms of their star rating and historical risk-adjusted returns?

Justice: Sure. All of these are going to be 5-Star rated funds, and the two standouts at the top that have over $2 billion invested in them already, it is a Morningstar favorite fund, it's Vanguard Dividend Appreciation Fund, the ticker is VIG. And it's giving you that large cap core exposure, really driving into the high quality equity segment. We think that this is a great way to fill what – you deem to be the high quality segment based on all the screens that Vanguard and Mergent has put this fund through. We think it can be a great core holding in a portfolio.

And also is the SPDR S&P Dividend Fund, and that's going to screen through the S&P 1500 for the stocks that have above-average dividend yields and a long track record of dividend growth, so it's going to give you a nice core income component to your equities. And again, you've got great deal of market liquidity there, and it could be another great component to really give your portfolio kind of that value to producing a lot of income, granted it does venture into the mid cap space a bit, but it's still mainly a large cap focused fund.

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