You’d think a homebuilder ETF would own mostly homebuilder stocks. A best ETF targeting vegetarian solutions to climate change would have top holdings in plant-based companies. And among the best ETFs, a “social sentiment” fund would get you quickly in hot meme stocks like AMC Entertainment (AMC).
You’d be wrong.
Less than a third of the holdings of SPDR S&P Homebuilders ETF (XHB) are in actual homebuilders’ shares. The US Vegan Climate ETF (VEGN) counts tech giants as its top two holdings. And the VanEck Vector Social Sentiment ETF (BUZZ) owned neither AMC Entertainment (AMC) nor GameStop (GME) during their huge social-induced buying frenzy in January — missing out on the bulk of their gains.
And that’s just the tip of the little secret in the world of exchange traded funds, or ETFs. Many carry catchy, easy-to-remember names. But in some cases, you’re not getting what you think. And it’s more important than ever now to know what you’re buying as scores of new ETFs launch and money pours in.
ETF Themes Aren’t Always What They Seem
ETFs’ names and implied themes are departing from the investment objectives they present. And not by a little. What’s actually inside an ETF can vary wildly from what a reasonable investor would expect or from other ETFs investing in the same theme, says Dave Nadig, director of research at ETFDB.com, a research firm that monitors what’s inside ETFs.
Let’s say you want to invest in a plant-based food future. You might look at the US Vegan Climate ETF (VEGN). What’s the top holding? It’s not plant-based food leader Beyond Meat (BYND). Beyond is not even in the top 10. It’s just 0.05% of the ETF.
So what dominates the vegan climate ETF? Software giant Microsoft (MSFT) accounts for 4.6% and chipmaker Nvidia (NVDA) 4.8%. Those aren’t just exceptions, either. Information technology stocks account for more than half the vegan ETF, at 52%, says ETF.com.
That’s not to disparage those tech stocks. They’re both well-run and Microsoft is an IBD Long-Term Leader. But it takes some imagination to grasp the vegetarian link.
“As far as ETFs whose portfolios match their labels like paisley matches plaid, I think that VEGN is the worst offender, but it’s not alone,” said Ben Johnson, ETF analyst at Morningstar.
Here’s another example. The First Trust Global Wind Energy ETF (FAN) targets global leaders in the wind power industry. And its top holding fits the bill: Vestas Wind Systems (VWS), a Denmark company that installs wind turbines.
But curiously, Duke Energy (DUK) is the No. 9 holding in the ETF. Just 5% of Duke Energy’s regulated power generation in 2019 used renewables such as solar and wind. The company has plans to bump that up, but to only to 14% by 2030, behind gas and nuclear.
“While there’s always ‘a reason,’ there are a lot of holdings that catch people by surprise in anything thematic related, honestly,” Nadig said.
Do You Know What’s In Your Best ETFs?
And that’s not to mention the wide range of stocks you might find in ETFs targeting the same theme, like space. Billionaires like Virgin Galactic‘s (SPCE) Richard Branson, Amazon.com’s (AMZN) Jeff Bezos and Tesla’s (TSLA) Elon Musk are launching rocketry companies. Regular investors want in, too. ARK Space Exploration & Innovation ETF (ARKX) already holds more than $600 million in investors’ assets.
But lifting up the hood shows a wide range of holdings. Virgin Galactic, one of the hottest space stocks, has nearly doubled in value this year. But ARK Space Exploration doesn’t own Virgin Galactic. Instead, the ETF puts 1.5% of its portfolio in farm-equipment maker Deere (DE) and 2.6% in video streamer Netflix (NFLX). And ARK’s space ETF puts 6.9% of its holdings in the fund family’s 3D Printing ETF (PRNT).
In fact, the three space-themed ETFs — ARK’s, the Procure Space ETF (UFO) and Direxion Moonshot Innovators (MOON) — overlap with just 20% of holdings, Johnson says. They’re completely different ETFs. But they sport catchy symbols like UFO and MOON.
“This disconnect speaks to the inherent subjectivity of assigning stocks to industries, categories, themes, etc. — opinions will vary,” Johnson said.
Finding The Best ETFs
Investors who buy the best ETFs based on the catchy names or symbols might expose themselves to risks they don’t realize. That danger rose to the fore this year during the meme stock rally. Small stocks shot up practically overnight on buzz on social media and message boards like Reddit.
Those are exactly the kinds of gains you’d think you’d capture owning VanEck Vectors Social Sentiment ETF (BUZZ). But you didn’t, says Lara Crigger, managing editor of ETFTrends.com.
“Given its connection to Dave Portnoy and its social network-scraping methodology, many investors expected it would hold the sort of fast-moving meme stocks that have been absolutely dominating headlines,” she said. “However, BUZZ didn’t add GameStop until fairly late in its meme-cycle, and it still doesn’t have AMC, which is the new hotness.”
AMC is the top-performing stock this year, turning $10,000 into $200,000 in just the first five months of the year. But after its June 2 spike, AMC stock has been trending lower.
Why the miss? Two reasons. BUZZ only reconstitutes its index monthly, Crigger says. “It adds new socially popular stocks to its portfolio on a lag, sometimes up to several weeks after they’ve already begun to catch on. And in the lifetime of an internet meme, a couple weeks might as well be centuries,” she said.
Additionally, BUZZ’s index maintains a minimum market capitalization for stocks it holds. “That minimum market cap requirement knocks out the true small and micro cap names, which tend to be the ‘meme’-iest stocks,” Crigger said. “What’s left is a portfolio of large-ish small-cap and midcap names.”
And then there’s the FOMO ETF (FOMO), which is supposed to own stocks so hot you’re “fearful of missing out” on them. The ETF launched May 25 with an objective: “The Fund takes its name from the phrase ‘Fear of Missing Out’ and seeks to reflect current or emerging trends.”
But the top three holdings as of the May 31 fact sheet were Keurig Dr Pepper (KDP), UnitedHealth (UNH) and Cisco Systems (CSCO), hardly stocks anyone is fearful of missing. Keurig Dr Pepper is lagging the S&P 500 this year and the other two are up roughly in line with the S&P 500.
The portfolio has since been rebalanced, making cash its top holding at 1.5%. Social media firm Sprout Social (SPT), up nearly 100% this year, is now the top stock holding at 1.3%.
Want To Play A Theme? There’s An ETF For That
Why are best ETF providers so interested in marketing? The popularity of the best ETFs is exploding, especially those tied into hot investment themes.
More than $77 billion poured into ETFs just in June, says State Street Global Advisors. It was the eighth straight month of inflows of $50 billion or more, for a total of $466 billion just in the first half of 2021. That was 90% more than the previous first half record in 2017.
And there are good reasons: low costs, tax efficiency and the ability to buy and sell like just like any stock.
One corner of the ETF universe is especially popular: thematic funds. Want to invest in the solar industry theme, but don’t want to try to pick the ultimate winning companies? There’s a solar-themed ETF for that. You can own a swath of solar companies. Similarly, want to bet on the comeback in airlines, without owning individual carriers? Own them all with an airline ETF.
So-called factor and thematic equity funds pulled in $83 billion in the 12 months ended May 2021, according to CFRA.
All you need is a buzzy name and theme. And it doesn’t really matter what’s in the best ETF. There’s even an ETF targeting happiness. The Infusive Compounding Global Equities, with symbol JOYY of course, targets companies that supposedly make people happy.
Rosenbluth says more than 200 ETFs launched in the first six months of 2021, including 51 in June alone.
Thematic funds are billed as easy one-trade ways to buy into specific sectors, trends or themes. But even among funds touting big, much-discussed concepts, you might be surprised to learn what’s in them.
ESG ETFs, which target companies that meet high environmental, social and governance standards, are the most important example. Advisors and money-managers looking to satisfy green mandates might just look at buying an ESG ETF. And lots of investors are.
More than $3 billion poured into ESG ETFs in June, the 29th straight month of inflows. These funds now hold more than $100 billion in assets, State Street says.
But a closer look shows the term ESG by itself is hardly defined. The $17.9 billion iShares ESG Aware MSCI USA ETF (ESGU) puts 0.65% of its portfolio in Exxon Mobil (XOM), which recently lost a proxy fight due to management’s resistance to shifting from fossil fuels.
Similarly, gold miner best ETFs are full of silver and copper companies, Nadig says.
The issue is that methodologies vary wildly. Some ESG ETFs must include all 11 S&P 500 sectors, including energy. Others take a more pure approach.
“Investors need to go beyond the name and look inside the fund to understand what will impact performance going forward,” said Todd Rosenbluth, head of ETF and mutual fund research at CFRA.
ETFs: Know What You Own
It’s not all nefarious. ETFs’ unique styles are often intentional. Investors just may not realize it.
Take the SPDR S&P Homebuilders ETF, which has nearly $2 billion in assets. It’s a go-to play for investors looking to take part in a massive homebuilding boom. But here’s the trouble: Only two of its top five holdings are actually homebuilders. And market leader PulteGroup (PHM) only accounts for 3.6% of the fund’s portfolio.
Instead, the homebuilder ETF’s top holding is home improvement retailer Floor & Decor (FND), with a 3.8% weighting. Also in the top five is home goods seller Home Depot (HD), with a 3.6% position. Both sell to consumers and builders.
Luxury furniture seller RH (RH) is also a top holding, at 3.5%. It’s not a mistake. The ETF tracks the S&P Homebuilders Select Industry index, which intentionally avoids overweighting giant homebuilders by equal-weighting all holdings.
It’s working out fine for now. RH stock is up more than 50% this year, blowing away the roughly 20% gain in shares of PulteGroup. Investors just need to know there’s a major retail stock exposure.
A rival ETF, iShares U.S. Home Construction, weights holdings by market value so homebuilders account for a much higher 65%, Rosenbluth says.
Even key asset classes are affected, with the best ETFs’ holdings that may not fit the allocation you’d expect.
The iShares US Financials (IYF) holds a 19% stake in real estate companies, Rosenbluth says. This is potentially an issue that could overexpose investors to real estate unknowingly.
Investors owning emerging markets best ETFs might have completely different exposures, too. The iShares MSCI Emerging Markets ETF (EEM) holds a 15% position in stocks from South Korea, Nadig says. But the Vanguard FTSE Emerging Markets ETF (VWO) holds none.
Steps To Investing In The Best ETFs
The popularity of thematic investing continues to fan demand for ETFs to suit any fancy. And regulators are already taking a look.
The Securities and Exchange Commission is stepping up its oversight on ESG disclosures. It announced in February an effort to take a closer examination of climate-related disclosures in public filings.
But it’s ultimately up to investors to look beyond an ETF’s name and to its prospectus to know exactly what they own. Tools at ETFDB.com and ETF.com allow you to look at an ETF’s top holdings.
You can also look up the portfolio’s concentrations in industries and sectors. Fund providers give breakdowns of their holdings and sectors in regulatory filings.
“Asset managers seek to make ETF investing simple hoping investors will use the easy button,” Rosenbluth said. “But the index behind an ETF, or the active manager, often has a broader universe of stocks that are considered and warrants a little homework.”