How To Select the Best in Class ETF

How the Deep Value ETF Accumulator Selects a Best in Class Fund

First, I must know that the class of funds that I am selecting has a reasonable chance of meeting or beating the total returns of a broad market index such as the S&P 500. This step is prudent, because, if the sector or category of funds that I’m considering investing in cannot perform at this level, then I would rather just own the major index. So, with that in mind, we’ll look at the Utilities Sector and see how it stacks up against the broad U.S. Stock Market index. Although I am using the Utilities Sector as an example, the analysis I perform is the same analysis I would do when deciding which sectors or markets I will invest in. The conclusion of this analysis will result in the same Utilities Sector fund that I currently own and continue to invest in.

To find out whether a sector or market can outperform, I must choose a benchmark. I personally think the S&P 500 index is a suitable benchmark to back-test against. Now that I’ve selected a benchmark, I can proceed to screening for relatively old and stable ETFs in that sector. I have used my Scottrade account’s ETF screening tool to find all the sectors and markets that outperform the S&P 500. You can use your own broker’s screening tools or any other online ETF screening tool that you like. The only parameter I use to find great sectors is: positive CAGR (compounded annual growth rate) over the last 10 years (> +1%). In the chart below, I show that analysis of just the Utilities Sector, to keep it short.

Look at VPU’s returns since inception at 10.11%. Also, look at the 10-year return of RYU at 7.08%. This sector might be investable. Also note the inception date on XLU. Since XLU is the oldest in this sector we’ll start our back-testing with it. I primarily use portfoliovisualizer.com for this analysis.

My back-test analysis tells me that I have found a sector that is worth investing in. Notice the CAGR is 1.15% higher than the S&P 500. Additionally, the correlation coefficient to the broad US market is a very low 0.40. This may prove beneficial to overall portfolio volatility and some occasional tactical rebalancing. Now that I know I have a sector that is investable, I move on to comparing all the Utility ETFs in the list head-to-head. I will begin with the 3 newest funds (RYU, JXI, PUI) and work my way down to the oldest because I can only compare 3 funds at a time on portfoliovisualizer.com. This order also tends to give a slight advantage to the older funds.

In the chart above you can see RYU is the winner in this round. Now let’s compare RYU with the next 2 ETFs (VPU, IDU).

Once again, RYU has come out on top, but VPU is a close second. Next, I’ll compare RYU with the last remaining fund, XLU.

And again, RYU comes out on top. I have now selected, in my opinion, the best ETF in the Utilities sector. At this point, I check the ETF Deathwatch list to make sure RYU is not on that list. I checked the list at this website: http://investwithanedge.com/etf-deathwatch/april-2017  RYU is not on the list. Now, to be an astute investor, I will go and read the prospectus for RYU. This is your due-diligence.  I read it and I like the fact that it is an equal weight ETF. Equal weight is beneficial in some sectors and not in others. Equal weighting helps bring down the average size of companies in the fund, and typically over long periods of time, smaller companies have higher returns than larger size companies. I also like the fact that it holds telecom companies in it. You can get the prospectus here: http://gi.guggenheiminvestments.com/products/etf/details?productId=86.

Here is the fund’s objective: INVESTMENT OBJECTIVE The investment objective of the Guggenheim S&P 500® Equal Weight Utilities ETF (the “Fund”) is to replicate as closely as possible, before fees and expenses, the performance of the S&P 500® Equal Weight Index Telecommunication Services & Utilities Total Return (the “Underlying Index”).

Thank you for taking time to read my blog folks. If you have any question, write it in the comment section below and I’ll get back with you ASAP.

Sincerely, The Deep Value ETF Accumulator, aka Micah McDonald