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All Contents © 2019The Kiplinger Washington Editors
By Kyle Woodley, Senior Investing Editor
| January 2, 2018
How do you follow up a performance like what the market did in 2017? That’s the question most investors are asking after last year’s breakneck 25% run in the Dow Jones Industrial Average. Fortunately for bulls, history and the economic climate are on Wall Street’s side – and thus most of the best ETFs to buy for 2018 will center around remaining on offense.
Investors fearing a letdown following last year's breathtaking run should take heart. Prior to 2017, the Dow had improved by 25% or more nine times since 1950, according to LPL Financial’s Ryan Detrick. The market finished higher the subsequent year in all but one of those instances – and six times, the DJIA even pushed out another double-digit gain.
Economic tailwinds couldn’t be more favorable, either. Kiplinger’s is forecasting GDP growth of 2.6% in 2018, up from a 2.2% pace in 2017. Moreover, the Republicans’ tax overhaul – including a massive corporate tax-rate cut from 35% to 21%, as well as a one-time low repatriation rate on cash held overseas – has set the stage for a big year for businesses, including the potential for job growth, buyouts, massive share buybacks and special dividends.
This environment bodes well for stocks of all stripes. However, investors can eliminate some of the guesswork (and risk of disappointing single-stock performances) by riding the broadly rising tide via exchange-traded funds. Here, we highlight the best ETFs to buy for 2018 – a collection of core funds, aggressive plays and even a couple of protective picks. You know. Just in case.
Data is as of Jan. 1, 2018. Yields represent the trailing 12-month yield, which is a standard measure for equity funds. Click on ticker-symbol links in each slide for current share prices and more.
Type: Large-cap stock
Market value: $83.7 billion
Dividend yield: 1.8%
Beating the market is a difficult task for even the most experienced money managers. In 2016, only a third of active large-cap managers were able to beat the Standard & Poor’s 500-stock index. It was even worse over longer time spans; 88% of active managers underperformed the benchmark over a five-year period, and that number hit 92% for 15-year returns.
There’s plenty of virtue, then, in simply matching the S&P 500 index – a feat you can easily and cheaply accomplish via the Vanguard S&P 500 ETF (VOO, $245.29).
The Vanguard S&P 500 ETF tracks the blue-chip stocks in the ubiquitous index. At the moment, that includes a healthy smattering of technology stocks (24% of the fund’s holdings), as well as financials (15%), health care (14%) and consumer discretionary (12%). The index is weighted by market capitalization, which means the largest stocks have the most say in the fund’s performance. Right now, that’s Apple (AAPL), Microsoft (MSFT) and Google parent Alphabet (GOOGL).
This blended index represents the American economy, and the VOO is one of just three exchange-traded funds that allows investors to track it. Moreover, the tiny 0.04% expense ratio means you’re only paying $4 annually for every $10,000 invested, and if you have a Vanguard brokerage account, you’ll avoid trading fees on any purchases to boot. That makes the VOO not only one of the best ETFs for a core portfolio, but also one of the cheapest.
Type: Mid-cap stock
Market value: $44.2 billion
Dividend yield: 1.2%
Large-cap stocks should anchor your portfolio, but everyone can do well by having exposure to the market’s “sweet spot”: mid-cap stocks. Mid-caps – those companies worth roughly between $2 billion and $10 billion – still are small enough that they can produce gaudier growth figures than larger, more established companies. On the flipside, they’re likelier to have access to financing and have more diverse product lines than their small-cap brethren, making them safer to hold in market downturns.
As our own columnist Steve Goldberg writes, mid-caps outperformed large caps by 2 percentage points annually between 1926 and August 2016. And while small caps did edge out mid-caps by 0.4 percentage points over that same time, they were 14% more volatile.
One of the cheapest ways to access mid-cap stocks is the iShares Core S&P Mid-Cap ETF (IJH, $189.78), a broad, balanced collection of 400 mid-sized companies such as California-based bank SVB Financial (SIVB) and video game maker Take Two Interactive Software (TTWO). The current blend includes 17%-plus weightings in information technology and financial stocks, and IJH boasts at least a 5% weight in eight different sectors.
Type: Industry (Defense and aerospace)
Market value: $4.9 billion
Dividend yield: 0.9%
A few funds are set up to be winners in 2018 simply thanks to favorable political waters. For instance, a Republican-controlled Congress and executive branch, as well as seemingly nonstop tensions with North Korea, were a boon to defense stocks in 2017, and should continue to be so in 2018.
President Donald Trump signed a nearly $700 billion fiscal year 2018 National Defense Authorization Act in mid-December, though Congress still has to pass an appropriations bill. Should that happen, defense stocks across the board could bump up their profit guidance for next year.
The iShares U.S. Aerospace & Defense ETF (ITA, $188.11) is the largest ETF specializing in the defense sector, and it’s a who’s who of the types of companies that stand to benefit from an amenable Washington. This portfolio includes a few dozen companies such as United Technologies (UTX), whose products include laser warning systems and ejection seats; Lockheed Martin (LMT), which produces aircraft such as the F-35 Lightning II fighter and Black Hawk helicopters; and General Dynamics (GD), which produces Tomahawk missiles and M1 Abrams tanks.
The ETF’s top weight, Boeing (BA, 10.9%), is better known for its commercial jet manufacturing, though it still makes numerous military products including the B-52 bomber, Chinook helicopters and Phantom Eye surveillance drones.
Type: Industry (Banking)
Market value: $314 million
Dividend yield: 1.4%
One of Trump’s hallmark campaign promises was that he would deregulate the financial industry to help banks and other institutions more easily generate profits. While that’s certainly a boon to mega-banks like JPMorgan (JPM) and Wall Street firms like Goldman Sachs (GS), this also should shine on smaller regional banks and credit unions.
This idea got even more traction when Trump tapped Jerome Powell in 2017 as his nominee to become the next Federal Reserve chair. Powell, in talking about potential changes he would make, said smaller institutions could use less stringent regulation.
That bodes well for the roughly 180 holdings of the First Trust Nasdaq ABA Community Bank Index Fund (QABA, $52.42). The QABA invests only in Nasdaq-listed banks – backing out the 50 largest based on asset size, as well as “international” or “credit-card” specializations. That results in a portfolio whose stocks average just about $925 million in market capitalization, and include the likes of California-based PacWest Bancorp (PACW) and Southeastern U.S. financial Bank of the Ozarks (OZRK).
These are mostly straightforward banks offering things such as checking services, car loans and mortgages – businesses that also could get a lift should the GOP’s recently passed tax overhaul generate the hoped-for boost in economic activity.
Type: Thematic (Robotics and automation)
Market value: $2 billion
Dividend yield: N/A
One theme that should reign supreme no matter who is in office is the increase of industrial robots and automation. The use of machines in manufacturing is hardly new, but systems are becoming increasingly complex, efficient and less reliant on human labor to operate.
William Studebaker, President and CIO of ROBO Global – which provides the Robo Global Robotics & Automation Index ETF (ROBO, $41.32) – told us back in December: “We are in the middle of a robotics arms race. These are technologies that companies need to invest in to stay relevant. When you look across all industries, the pace of investment is only accelerating.”
Yes, the additional profits that should come thanks to the GOP’s tax cuts should end up financing even more investment in automation, but that’s coming anyway. The industrial control and factory automation markets are expected to grow at 7.4% annually to $239 billion in 2023.
The ROBO ETF is one of the best funds to buy if you want to capture this potential. The fund’s roughly 100 holdings include industrial specialists such as Rockwell Automation (ROK) and ABB (ABB), but also other plays in the automation space, such as subsea systems provider Oceaneering International (OII) and German packaging and bottling machine maker Krones.
Type: Industry (Internet)
Market value: $5.5 billion
The internet is no longer an emerging trend, and in fact powers three of America’s five largest companies by market capitalization – Google parent Alphabet, Amazon (AMZN) and Facebook (FB). But just a quick look at analysts’ 2018 growth prospects for all three indicates that the industry still has boatloads of potential for capital appreciation.
No matter where you look, it’s clear that the internet’s share of dollars is growing. Statista projects retail e-commerce spending will balloon from $409 billion in 2017 to $638 billion by 2022. Online advertising, where Facebook and Alphabet reign, already surpassed TV advertising in 2016, and is expected to grow by 9.9% annually to $116 billion by 2021.
Enter the First Trust Dow Jones Internet Index Fund (FDN, $109.88). This roughly 40-stock fund is one of the best ETFs to take advantage of the swelling internet market. In addition to large holdings in Facebook, Amazon and Alphabet, FDN also provides exposure to streaming content king Netflix (NFLX), online payments titan PayPal (PYPL) and cloud veteran Salesforce.com (CRM).
Every company in this fund must generate at least 50% of its annual revenues online, so FDN is a pretty pure play on the internet. Moreover, while the median market cap of $6 billion indicates a smaller, riskier portfolio, much of the fund’s weight is wrapped up in well-financed large-caps that should provide a little stability amid any market tumult.
Type: Thematic (Emerging-market internet)
Market value: $393.2 million
Dividend yield: 0.4%
The future of the internet and e-commerce in America is plenty exciting. But what’s going on in higher-growth markets elsewhere in the world is enough to make one’s heart skip a beat.
Consider this: Chinese e-commerce sales are expected to grow 10% annually between 2016 and 2021, according to BI Intelligence. South Korea is projected at 13% growth, while Latin America should expand by 16%. None of that holds a candle to India and southeast Asia, which are forecast to explode by 31% and 32%, respectively, every year through 2021.
That’s because the world’s emerging economies, while “poorer” than the U.S., still are exceedingly well-connected, with mobile banking and buying options every bit as advanced (and perhaps more so) as here in the States. And that means massive profit growth potential for the innovators in all these markets.
The Emerging Markets Internet & Ecommerce ETF (EMQQ, $38.06) is a collection of roughly 50 of these could-be dynamos. The lion’s share of the fund (65.1%) is invested in Chinese companies such as e-commerce platform operator Alibaba (BABA) and internet and gaming giant Tencent (TCEHY). However, it also has exposure to Russia via companies such as search operator Yandex (YNDX), as well as Latin America via Argentina’s MercadoLibre (MELI).
This isn’t a cheap ETF, at 0.86% in annual expenses. However, EM funds to tend to cost more than domestic funds, and even if it only occasionally produces years like the 68% return it had in 2017, it will more than justify its fees.
Type: Thematic (Share buybacks)
Market value: $38.8 million
One of the most widely made assumptions about the Republican tax overhaul is that allowing companies to repatriate cash held overseas will result in big expenditures in dividends and stock buybacks. That assumption looks awfully good considering December share repurchase announcements by the likes of Bank of America (BAC) and Home Depot (HD).
Ted Theodore, Vice Chairman and Chief Investment Officer of TrimTabs Asset Management, and portfolio manager of the TrimTabs All Cap US Free-Cash Flow ETF (TTAC, $33.72), agrees, with a big caveat – namely, the Federal Reserve’s policy of continuing to increase interest rates may counter short-term activity spurred by a one-time low repatriation rate. “The vast majority of buybacks in the last five or six years has been financed largely out of offering debt,” he says. “Clearly, that will be a more expensive proposition for the marginal corporation to contemplate. There will be higher financing costs than we have seen.”
However, the TTAC ETF, which targets companies that aggressively repurchase shares, still should enjoy the benefits of stock buybacks because of the companies it tends to invest in. Namely, the fund’s selection methodology not only focuses on repurchases, but also corporate balance sheets and free cash flow. “We end up with companies with good, organic growth,” Theodore says. “If a company is able to reduce its share count without resorting to issuing debt, all the better.”
TTAC is an actively managed fund with 100 holdings, equally weighted at each rebalancing at 1%. As stocks rise and fall, their weight changes a little bit, but top holdings Southwest Airlines (LUV) and Match Group (MTCH) still only make up 1.3% of the portfolio each, making this a very balanced fund with little single-stock risk.
Type: Sector (Real estate)
Market value: $394.4 million
Dividend yield: 7.3%
Income investors should have at least a little familiarity with real estate investment trusts (REITs) – a special business structure for real estate owners and operators that are required to pay out at least 90% of their taxable income as dividends. It’s not uncommon for REITs to boast yields of 5% to 7%.
However, while ETFs typically are a great way of gaining exposure to various market sectors and industries, most fund offerings don’t reflect many of the high yields of the space. Consider that the Vanguard REIT ETF (VNQ) yields just more than 4%, and the uber-cheap Schwab US REIT ETF (SCHH) yields less than 3%.
But the PowerShares KBW Premium Yield Equity REIT Portfolio (KBWY, $35.41) has it where it counts, delivering a 7.3% yield at present. Of course, it does so by focusing on a tight portfolio of small- and mid-sized operators that it also weighs by yield.
The downside is that KBWY isn’t terribly diversified, with top holdings like Washington Prime Group (WPG), DDR Corp (DDR) and New Senior Investment Group (SNR) commanding 5%-6% weights in this roughly 30-stock fund. Nonetheless, KBWY has been one of the best ETFs in the REIT space by total return over the past few years, thanks in part to the enormous difference in annual payouts.
Type: Short-term Treasury bond
Market value: $1.9 billion
SEC yield: 1.8%*
Most portfolios can use a little bond exposure, too, whether it’s for long-term income generation or even occasionally as a short-term market hedge. The Vanguard Short-Term Treasury ETF (VGSH, $60.28) is primarily targeted at the latter.
The VGSH holds 140 U.S. Treasury bonds – some of the world’s safest, highest-graded debt. On the upside, that means bondholders can feel pretty secure about receiving all interest payments and principal in full. On the downside, that means Treasury debt is highly sought-after, and as a result, the U.S. doesn’t have to offer much in the way of interest rates. Indeed, VGSH currently yields a meager 1.8%.
But that’s OK. The point of this kind of investment is short-term security – something VGSH has in droves. That’s because in addition to its high creditworthiness, the bonds are extremely short-term in nature, between one and three years in maturity, making the fund far less susceptible to interest-rate changes.
Thus, VGSH is very much a safety play for volatile and down markets. Rather than going completely to cash where your money will earn nothing, funds like Vanguard Short-Term Treasury provide some measure of protection while delivering at least modest returns.
* SEC yield reflects the interest earned for the most recent 30-day period after deducting fund expenses. SEC yield is a standard measure for bond funds.
Type: Junk bond
Market value: $1.2 billion
SEC yield: 5%
The VanEck Vectors Fallen Angel High Yield Bond ETF (ANGL, $29.95) – a member of the Kiplinger ETF 20 – is another bond fund, but not nearly as defensive in nature as the VGSH.
“Fallen angels” are a term for bonds that were rated “investment-grade” when they were issued, but have since fallen to below investment-grade. Put another way, they’ve gone from being viewed by the major credit ratings agencies as relatively safe investments to more speculative in nature.
However, while that implies a great deal of risk, ANGL isn’t as dangerous as it might sound. Nearly three-quarters of the portfolio has a composite rating of BB – the highest “junk” rating available – with another 21% a step below, at B. Only 4% of the portfolio is rated lower than that (or not rated at all). That’s actually a much higher overall credit quality than the portfolios of most traditional junk funds.
That makes ANGL something of a “tweener” fund – not exactly corporate investment-grade, but not deep junk, either. Yet investors still are rewarded with an ample 5% in yield that helps compensate for the risk.
Type: Emerging-market bond
Market value: $367.4 million
SEC yield: 5.6%
Another place income investors can search for yield is emerging-market debt. Yes, bonds issued by countries such as Venezuela, Kazakhstan and Zambia might seem akin to walking a tightrope, but the VanEck Vectors Emerging Markets High Yield Bond ETF (HYEM, $24.48) helps everyday investors enjoy the high income of this space without taking on excessive risk.
For one, those aforementioned countries make up smaller parts of the portfolio. China is the most prominent country at 12.8% of the portfolio, with Brazil, Turkey, Argentina and Russia garnering high-single-digit weights. Moreover, there’s strong diversification across nearly 400 bonds from roughly 50 nations.
While the credit quality isn’t as high as ANGL, it’s not too far off. BB-rated bonds make up about 60% of the portfolio, with B another 30% – an overall better ratings profile than the popular SPDR Bloomberg Barclays High Yield Bond ETF (JNK). Moreover, the average maturity of the bonds held in HYEM is 5.4 years, which still is on the shorter end of the spectrum.
The tradeoff of this moderate but still manageable risk is a high 5.6% SEC yield.
Market value: $1.4 billion
Mike Tyson famously said, “Everyone has a plan until they get punched in the mouth.” While we wouldn’t recommend taking specific investing advice from Iron Mike, you can take a broad lesson away from this. That is, you can build a long-term plan with rock-solid holdings and have every intention of riding them out through thick and thin – but if the market turns ugly like it did in 2007-2009, it’s easy to panic and throw the good out with the bad.
The solution? When that punch comes, remember the ProShares Short S&P 500 ETF (SH, $30.18).
ProShares’ SH is an easy way for individual investors to hedge against a bear market. The fund provides the inverse daily return of the S&P 500, which in short means that if the S&P 500 declines by 1%, the SH should gain 1%. Should you find yourself in a down market but have many long-term holdings with good cost bases, ample yields and the ability to keep producing returns once the market recovers, the SH allows you to essentially recover some of the losses in your long portfolio.
The natural downside to look out for is that if you’re holding SH while the market recovers, you’ll blunt the gains of your long holdings – but that’s the risk you take with many market hedges.
Type: Thematic (Cloud)
Market value: $236.7 milliion
Dividend yield: 0.82%
The ARK Web x.0 ETF (ARKW, $46.07) might be best listed alongside the other industry and thematic funds we discussed earlier. However, its current construction also makes it interesting as something of a small market hedge.
The ARKW is a tech-centric fund that holds companies “focused on and expected to benefit from shifting the bases of technology infrastructure to the cloud,” which turns out to be a fairly wide mandate that allows everything from companies such as Amazon, which has the world’s largest cloud platform in Amazon Web Services, to companies such as healthcare-tech specialist AthenaHealth (ATHN), as well as 2U (TWOU), which enables colleges and universities to provide online degree programs.
It also allows ARKW to hold a high 7.1% weight in Bitcoin Investment Trust (GBTC) – an over-the-counter-traded fund that tracks the cryptocurrency Bitcoin. GBTC is far from a perfect product, sporting low trading volume and currently priced at a significant premium to the Bitcoin it holds. But it’s also one of the easiest ways to gain exposure to Bitcoin, and it makes ARKW one of the few ETFs to have access to the cryptocurrency.
ARKW’s 1-2 punch of both Bitcoin and high-growth tech stocks made the fund a huge winner in 2017, gaining 87%. It could be a powerful combo again in 2018 – and even if the markets take a step back, ARKW still could produce decent gains should Bitcoin resume the brisk pace it maintained for much of last year.
Type: Multi-cap stock
Market value: $88 million
Artificial intelligence is one of the major investing buzzwords of the latter half of this decade, powering the fortunes of companies such as Nvidia (NVDA) that make this technology possible. But investors may be able to harness the power of AI in a different way – namely, the AI Powered Equity ETF (AIEQ, $25.89).
AIEQ, which was co-launched by EquBot and ETF Managers Group on Oct. 18, 2017, uses IBM’s (IBM) artificial intelligence system Watson to analyze literally thousands of American companies on a daily basis. The system scans news, SEC filings and even social media posts, going back as far as 10 years to come up with a portfolio of between 30 and 70 companies, limited to a maximum weight of 10%.
At the moment, AIEQ is heaviest in financial services (44.4%), followed by technology (14.1%) and consumer discretionary (13.6%). Amazon is its top holding at 3.6% of the fund. But given the fund’s methodology, investors should have no expectation that the fund will maintain that or any other sector distribution indefinitely – that should change as market conditions change.
The fund does sport a somewhat high expense ratio of 0.75%, and high turnover could generate additional trading costs that weigh on performance. However, this fund is able to analyze stocks in a way that no human can match, and time will tell whether that equates to market-beating returns. So far, AIEQ’s prospects have generated a ton of interest, with the fund drawing nearly $90 million in assets under management within just a couple months of trading.