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ETF Specialist

The Best and Worst New ETFs of 2020

There were a record number of new ETFs launched in 2020. These are our selections for the year's best and worst.

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As of Dec. 17, there were a record 276 new exchange-traded funds launched in 2020. This marks the fastest pace of new launch activity since the prior record was set in 2015. There are now 2,288 ETFs available to investors. Since SPDR S&P 500 ETF (SPY)  was launched in 1993, 3,291 ETFs have been brought to market. This means that about 30% of them have since been closed. In 2020, a record 179 ETFs shut down.

Though there are plenty of choices on the ever-expanding menu, investors' tastes are basic. Of the 2,288 ETFs currently on offer, the top 100 as measured by assets under management accounted for 70% of the $5.5 trillion invested in ETFs at the middle of December. The top 100 are the Swiss Army knives of the ETF world. They are efficient multipurpose tools that do a lot of different jobs for a lot of different types of investors.

These figures are all fun fodder for banter among industry watchers, but what do they mean for investors? First, they demonstrate that the best options have been on the menu for a long time, right in front of their noses. Second, it means that the odds of something better coming to market have grown slimmer over time. It's going to be awfully difficult to beat funds backed by solid sponsors that offer instant access to the entire U.S. stock market at a cost of 0.03% per year or the universe of U.S. investment-grade bonds for nothing.

With all this in mind, our ETF research team has taken a close look at the class of 2020 and voted on what we believe were the best and worst new ETFs launched this year.

The Best
It's difficult to stand out in this cramped landscape. If anything, sticking out from the crowd can be detrimental. The traits of successful new entrants are often no different than those of existing best-of-breed funds: time-tested strategies, low fees, and a solid sponsor. Ideally, it is also good to see early signs of long-run viability as measured by AUM and flows. This helps instill confidence that these funds will be around to serve investors for a long time.

DFA Enters the ETF Fray
Dimensional Fund Advisors finally entered the ETF fray, launching three in late 2020. The firm also plans to convert six of its tax-managed mutual funds to ETFs in 2021. While its ETFs are new, DFA is no stranger to the ETF market. Since 2015, it has subadvised John Hancock’s range of ETFs, which track indexes that contain DFA’s DNA.

Unlike those John Hancock ETFs, DFA’s offerings are actively managed. They will ply the same strategies as their mutual fund predecessors, balancing the benefits of broad diversification with tilts toward, smaller, cheaper, and more profitable stocks in an attempt to improve returns.

Our favorite among the three is Dimensional U.S. Core Equity Market ETF (DFAU). The fund’s process mimics that of its mutual fund predecessor DFA U.S. Core Equity 1 (DFEO). But DFAU delivers that strategy in a wrapper that is more cost-efficient, more tax-efficient, and more widely accessible.

While DFAU and DFA U.S. Core Equity 1 charge like fees of 0.12%, investors can buy or sell its shares without paying a commission at a number of brokerages. This is particularly appealing to advisors that are still paying ticket charges to transact in Dimensional’s mutual funds on behalf of their clients. The regular use of in-kind creations and redemptions means that DFAUS will be more tax-efficient than the elder mutual fund, which has regularly distributed modest capital gains distributions in recent years. Finally, broad availability is an interesting departure from DFA’s historical approach to maintaining a selective clientele. Given that its ETFs trade on exchanges, any investor can purchase them in an amount as little as a single share--currently around $26 in the case of DFAU. This opens Dimensional’s offering to a much wider audience. There is a lot to like about repackaging one of Morningstar’s top-rated U.S. stock strategies (DFA U.S. Core Equity 1 carries a Morningstar Analyst Rating of Silver) into a more investor-friendly format.

A Broader Basket of Bonds Through an ESG Lens
IShares ESG Advanced Total USD Bond Market ETF (EUSB) was launched in June. EUSB is the ESG cousin of Gold-rated iShares Core Total USD Bond Market ETF (IUSB) and an ESG sibling of Silver-rated iShares ESG U.S. Aggregate Bond ETF (EAGG), which made our list of the best new ETFs of 2018.

EUSB starts with the spectrum of investment-grade and high-yield bonds in the Bloomberg Barclays Universal Index. From there, it screens out issuers involved in certain lines of business, those with low MSCI ESG ratings, and any with exposure to severe controversies.

As measured by ESG characteristics, EUSB’s screens are effective. Its MSCI ESG Quality Score and Average Carbon Intensity are both materially higher than IUSB’s. From a fundamental perspective, there are important differences between the two funds’ portfolios. Specifically, EUSB takes significantly less credit risk and incrementally less interest-rate risk. The fact that EUSB screens out firms with fossil fuel involvement partly explains this discrepancy as such issuers feature prominently in the high-yield space.

All told, EUSB is a welcome addition to a slim menu of ESG intentional bond funds. The fund balances broad diversification with ESG incorporation and charges a low 0.12% fee.

The Worst
There were plenty of suspect newcomers in the crowd in 2020. A common thread among many of them is that they prey on investors' impulse to chase what's hot. These funds tend to offer narrow and/or overly complex exposures, charge high fees, and have sponsors that prioritize salability over staying power.

Thematic funds tend to feature prominently on our list of the worst new launches. This year is no different. These funds generally attempt to leverage a compelling narrative into something that sells--though isn’t always worth an investment. These funds have a tall task, as they have to get three things more or less right to succeed for investors: 1) the theme, 2) the portfolio, and 3) valuations.

Not all themes have staying power. Many thematic funds don't have portfolios that align with their theme to the extent investors might expect. And even if the first two pieces of the puzzle are in place, if investors’ enthusiasm for the narrative has stretched valuations, then long-run returns are likely to disappoint.

Working From Home
As the world went on lockdown earlier this year, we all had to adapt to new ways of living and working. For many, that meant working from home. Every. Day.

A number of companies have benefited from this situation, perhaps most notably Zoom Video Communications (ZM). The Zoom platform has helped professionals to collaborate and families to celebrate from afar. As of mid-December, its share price was up nearly sixfold for the year and trading at levels more than 2 times Morningstar’s fair value estimate.  

In this context, it was no surprise that there was not just one, but three work from home themed ETFs launched in 2020: Direxion Work From Home ETF (WFH), Emles @Home ETF (LIV), and iShares Virtual Work and Life Multisector ETF (IWFH). All three take different approaches to building portfolios that aim to help investors capitalize on this trend. But they have one important thing in common: They’re all trading well above their Morningstar fair value estimates. Even if the work-from-home movement continues and these funds have locked in on the right stocks, this leaves little if any room for long-term upside for investors.

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 does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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