3 Great ETFs for Contrarians

Contrarian strategies have a certain appeal. They tend to avoid popular stocks and gravitate toward names trading at prices below their true underlying value. Done well, these types of investments can provide great long-term performance. But the payoff may take a while to show up, so a long holding period is often necessary, and these strategies may incur some incremental risk for that additional reward. But there are some great options to consider.

The first ETF on my list is a true contrarian strategy. Silver-rated Schwab Fundamental U.S. Large Company Index ETF, which trades under the ticker FNDX, holds almost all of the large- and mid-cap stocks in the U.S. market. But it cuts against the grain when weighting its constituents, positioning stocks using several fundamental characteristics.

3 Great ETFs for Contrarians

These exchange-traded funds earn a Morningstar Analyst Rating of Silver or Gold.

1. Schwab Fundamental U.S. Large Company Index ETF FNDX
2. Dimensional US Small Cap Value ETF DFSV
3. Vanguard Total Stock Market ETF VTI

The index this ETF tracks assigns larger weights to names with greater sales, retained cash flows, and cash returned to investors through dividends and buybacks. When the index rebalances, it doubles down on stocks that have declined in price relative to those fundamentals, while trimming exposure to names on the rise. This buy-low tack sets the ETF up to capitalize on mean-reverting prices. But there is a downside. It may extend too much rope to floundering firms and prematurely cut ties with winners.

Leaning into stocks that look cheap steers this fund into value territory. But it pulls its holdings from the full value-growth spectrum, so it maintains some small stakes in growthier stocks. Along those lines, the ETF has managed to perform a little better than its peers during growth-friendly environments.

While this fund swims against the current, it manages to diversify away stock and sector-specific risks that could adversely impact performance. And it's available for a reasonably low fee. Schwab charges just 25 basis points per year for this portfolio.

Keeping the focus on value strategies, Silver-rated DFA US Small Cap Value ETF, ticker DFSV, also fits the contrarian mold. DFA launched this ETF earlier this year, and it mimics the same process used in its Small Cap Value mutual fund. Its emphasis on small stocks trading at lower price multiples steers it toward names that receive far less attention than those that are larger and more popular.

DFA's managers follow a strict set of rules to build this portfolio. They start with the smallest 10% of stocks in the U.S. market, then target the cheapest third by price/book ratio. They further refine holdings by avoiding names with poor profitability and aggressive asset growth—types of characteristics that have historically been associated with poor expected performance.

DFA's traders have some flexibility that helps cut back on the costs of trading these smaller stocks. They can substitute stocks with similar size and value characteristics, and they can buy and sell patiently to avoid costly trades. Those lower trading costs complement the ETF's relatively low expense ratio of 31 basis points.

The final ETF on my list isn't one that immediately fits the bill of a contrarian strategy. The U.S. market was down about 20% for the year through July 15, meaning it's that much cheaper than it was just six months ago. A broad total-market ETF, like Gold-rated Vanguard Total Stock Market ETF, is a great way to take advantage of lower prices, and it should be a great ETF for the long run. It trades under the ticker VTI, and it's among the best of breed when it comes to broad U.S. total-market index funds.

VTI holds stocks of all sizes and one of the most comprehensive portfolios in the large-blend category. It isn't likely to miss out on hot segments of the market, while its extensive diversification helps avoid many stock-, sector-, and style-specific risks.

Many of the largest U.S. stocks that dominate VTI's portfolio are closely followed, and their prices likely reflect the market's consensus opinion of their true underlying value. VTI captures those opinions through its market-cap-weighting approach. That leaves little room for active managers to carve out an advantage, and VTI has been very difficult for actively managed peers to beat. Its ultralow 3-basis-point expense ratio only adds to its attractiveness.

Daniel Sotiroff talks about three ETFs that make great long-term investments in “3 Great International ETFs Having a Tough Year.”