3 Highly Rated ETFs on Sale

Ben Johnson: Hi, I'm Ben Johnson, director of global ETF research, with Morningstar. Today, we're looking at three Morningstar Medalist ETFs that are trading at a discount to their Morningstar fair value estimates. Each of these funds is a Morningstar Medalist, meaning that they earn a Morningstar Analyst Rating of Gold, Silver, or Bronze. This indicates that we think these funds are among the best of breed within their respective Morningstar Categories. And all three of these ETFs are currently trading at a discount to their Morningstar fair value estimate, which is an aggregate of all of the fair value estimates, both qualitative and quantitative, for the individual stocks that these ETFs hold in their portfolios.

The first ETF that I'd like to highlight is the Schwab Emerging Markets Equity ETF. The ticker for this fund is SCHE. At present, SCHE is trading at a 28% discount to Morningstar's fair value estimate. SCHE combines a cost-effective approach with an ultralow fee that should help it perform well against its Morningstar Category peers. It earns a Morningstar Analyst Rating of Bronze.

The fund tracks the FTSE Emerging Index. This index covers large- and mid-cap stocks from 24 developing nations, including locally traded China A-shares. The portfolio excludes Korean stocks because FTSE, the index provider, classifies South Korea as a developed market. The fund weights its holdings by market capitalization. This is an approach that benefits investors by capturing the market's collective opinion on each stock's value while mitigating turnover and trading costs. While market-cap weighting can be tough to beat because the market tends to accurately value stocks over the long run, but occasionally, it will increase the fund's exposure to expensive stocks when investors get excited about an area of the market. But this doesn't undermine its long-term efficacy.

The fund's low 0.11% expense ratio has helped it to modestly outperform the category average over the decade through February. This is one of the least expensive funds in its Morningstar Category, and its rock-bottom fee should provide a long-term durable advantage.

The second fund I'd like to highlight is the iShares MSCI EAFE Small-Cap ETF. The ticker for this fund is SCZ. It's currently trading at about a 19% discount to its Morningstar fair value estimate. SCZ has a solid, well-diversified, low-turnover portfolio. While it isn't the cheapest index-tracking option in the foreign small/mid-blend Morningstar Category, it still has a substantial advantage over its peers. The fund earns a Morningstar Analyst Rating of Bronze.

It tracks the MSCI EAFE Small Cap Index, which includes small-cap stocks listed in 21 overseas developed markets. It weights its holdings by market cap. Much like the case with SCHE, this is an approach that benefits investors by capturing the market's consensus view of each individual stock's value while keeping turnover under wraps. Now, while markets usually get long-term prices more or less correct, they can occasionally make mistakes. Investors can drive valuations up if they get particularly excited about a corner of the market, and market-cap weighting will respond by increasing the fund's exposure to that market segment.

The fund's relatively low fee has helped it outperform many of its category peers. Its total return landed just inside the top 20% of its category peers, while its volatility has been comparable over the long run. BlackRock charges an expense ratio of 0.40% for this fund. This fee is fairly cheap within its Morningstar Category and should continue to provide the fund with a long-term advantage.

The last fund I'd like to highlight, which is currently trading at a 16% discount to its Morningstar fair value estimate, is the iShares MSCI USA Value Factor ETF. VLUE takes a sector-relative approach to portfolio construction that uncovers stocks that are truly cheap relative to their peers and shields the fund from sector biases that tend to plague most traditional value indexes. This unique advantage should help the fund outpace the Russell 1000 Value Index over the long run and earns it a Morningstar Analyst Rating of Silver.

This index strategy compares stocks' value characteristics to their sector peers. This distinguishes it from most value indexes. Rather than favor traditional value-friendly sectors, like financials and real estate, this portfolio absorbs cheap stocks all over the market sectors. It anchors its sector composition to the broad market as well, further curbing any unintended sector bets and avoiding the sector biases that most value index funds develop. This is an advantage, as it's an active risk that the market does not always reward. This fund may take heavier stakes in some sectors that become overvalued, but we think that's ultimately a worthy trade-off.

These three picks' valuations look appealing today, and each of them are among the best of breed within their Morningstar Categories.

I'm Ben Johnson for Morningstar. Thanks for watching.

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