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2 New ETFs We Like

We like both of these newcomers far more than most of 2021's trendy new launches.

Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. The first Bitcoin-related ETFs were perhaps the most talked about new ETF launches in 2021, but there were plenty of other newcomers this year. Joining me today to talk about some promising new ETFs that came to market in 2021, and some that aren't as promising, is Ben Johnson. Ben is Morningstar's Global Director of ETF Research.

Hi, Ben. Thanks for being here today.

Ben Johnson: Thanks for having me, Susan.

Dziubinski: So, 2021 was a record year for new ETF issuance. Give us some of the background on that.

Johnson: Yeah. So, in 2021, I think the ETF industry did its best Bonnie Raitt impression and gave us something to talk about--plenty to talk about, including, as you mentioned, the first ever, I'll call it a "Bitcoin-ish ETF" because it invests in Bitcoin futures and not directly in Bitcoin itself, and a whole slew of other ETFs, more than 400 in total, which is a new record by a massive margin. That encompasses everything from ETFs that invest in companies that are in some way involved in the manufacture or distribution of psychedelic drugs on one end of the spectrum, to now Fidelity Magellan, Peter Lynch's former charge, now in an ETF format on the other end of the spectrum, and everything in between on this continuum. So, the ETF industry has given us plenty to talk about, throwing a lot of pasta at the wall. It's unlikely that most of it will stick long term, but that's not to say that there aren't some interesting strands that we can pull on here.

Dziubinski: So, let's talk a little bit about some of those strands that might stick that are interesting to you and to our analysts. The first one that we're going to talk about is an ETF that puts an international spin on dividend stock investing, right?

Johnson: Yeah. So, Schwab International Dividend Equity ETF (SCHY) is the foreign cousin of a longtime favorite of ours, which is the Schwab US Dividend Equity ETF (SCHD), and it carries a Morningstar Analyst Rating of Silver. So, these two cousins have a lot of shared DNA. They look for stocks that have a history of paying dividends, at least a decade worth of history. They blend dividend growth and dividend durability with an emphasis on dividend yield, so sorting that universe by their forward yields. They screen based on a variety of fundamentals. The international cousin applies an additional screen that tries to tamp down volatility in that final portfolio, and what you get is a bundle of high-quality dividend-paying companies at a very compelling fee, so just 0.14% for this portfolio of topnotch foreign stocks bundled into SCHY. So, we like a lot about SCHY because we like everything about SCHD.

Dziubinski: So, another ETF that you guys think is somewhat promising comes from Dimensional Fund Advisors, and they've been making a push into ETFs in the past couple of years, and this one focuses on bonds, right?

Johnson: That's right. So, DFA has been late to the ETF party, but they've made a splash, first launching a standalone range of ETFs in 2020 and 2021, and making a bigger splash still by way of converting a half-dozen of their mutual funds to ETFs, which were among some of the first ever mutual-fund-to-ETF conversions. What we like about this particular fund is it applies a very familiar approach. It's an approach that Dimensional Fund Advisors has applied for ages now in fixed-income portfolios that aims to take very thoughtful risks in trying to add value relative to just owning a broad bond index. So, specifically measuring and taking on increments of interest-rate and credit risk where their research has shown that those risks might be adequately rewarded. Add onto that a very competitive fee, and we think this is one to watch.

Dziubinski: So, Ben, what's the name and ticker of this particular DFA fund?

Johnson: So, this is the Dimensional Core Fixed Income ETF (DFCF).

Dziubinski: So, let's pivot and sort of look at the other side of some of the new issuance this year, things that you might have called "suspect newcomers" in 2021, and a lot of these seem to fall into sort of the thematic fund bucket. Why is that?

Johnson: Well, that's really like where the only remaining frontiers are. When you look at the menu of ETFs today, a lot of the most broad-based, widely diversified core exposures have long since been covered off and then some. So, if you're in ETF product development, you've got to try to find, like, what is that next great frontier, what is that white space where we can do something that is in some way differentiated. So, directionally, in recent years, that's pulled them in, first, the direction of factors, strategic beta or smart beta, whatever you want to call it. More recently, what we've seen is a pull in the direction of thematic funds, so funds that invest in themes like artificial intelligence, electric vehicles, the blockchain, you name it, as well as ESG. This year, what we saw was another sort of host of different thematic funds, because these funds really just draw from the headlines. What is the topic do jour? What's on the cover of the Wall Street Journal or The Economist, and how can we slap that on the label of an ETF to try to create a compelling narrative, something that might be more interesting than just a broadly diversified total stock market index fund. And it's a trend that is really as old as time. So, while today we're talking about now metaverse-themed ETFs, you go back a few decades, and we were talking about internet-themed mutual funds. So, these are trends that are going to continue to perpetuate themselves, no different than trends in fashion, right? And I personally am hoping that at some point in time corduroy will once again be fashionable.

Dziubinski: So, let's talk a little bit about maybe a couple of ETF launches this year that we think--as opposed to the ones we talked about earlier that we think might stick to the wall--these might not stick that long.

Johnson: So, there's plenty to choose from, but one area in particular is interesting because it stands in stark contrast to some of what we identified as 2020's worst new ETFs in this thematic vein. And in particular, we singled out a trio of work-from-home-themed ETFs. Now, that was very timely, very topical when we were all living, working, and doing everything else from home. But now, as we sit here across from one another, it's clearly a trend that isn't going to have maybe the legs, isn't going to be as durable as many might have thought it would be. So, fast forward to 2021, and sure enough, what we've seen is that there have been any number of thematic ETFs launched to try to capitalize on the fact that we're all getting back out in the world, and we're going on vacation, and we're eating at restaurants, and we're getting back in commuter trains, and you name it. So, there's a number of those that we've called out this year as some of the worst new ETF launches, again, that are based on trends that probably aren't all that durable, that are coming to market at a time where it's already making headlines. So, if you think of the old adage of buying the rumor and selling the news, if anything, you should probably sell short when there are three or four or five different thematic ETFs that are trying to capitalize on a particular trend. And indeed, if you look at the long history of this category of funds, what we see is that most of these trends, most of these funds tend to fizzle out.

Dziubinski: Well, Ben, thanks for your time today and for putting these 2021 new launches into perspective. And given the momentum that ETFs have when it comes to new launches, I'm sure we're going to have plenty more to talk about in 2022.

Johnson: Plenty more to talk about. Looking forward to it, Susan.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.

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