Understanding Risk and Compensation in ETFs

Exchange-traded fund launches have continued to accelerate, but not every shiny new strategy is worth owning. Good investment strategies can compensate investors with an appropriate return for the risks they take on. What kinds of ETFs are able to deliver over the long term, and which ones fall short? Dan Sotiroff is joining me today to explain the hidden risks in stock ETFs and what investors should look out for. Dan is a senior manager research analyst for Morningstar Research Services and the editor of Morningstar’s ETFInvestor newsletter.

Can you talk about the idea that ETFs should be able to compensate investors for the risk they take on? What is an “appropriate level of return”?

When looking at the risk and return profiles of ETFs, the term “active risk” often comes up. Can you give us a definition?

What kinds of funds have the lowest active risk?

Can you give an example of two ETFs that appear similar but take on different levels of risk?

You’ve written that “any stock ETF with fewer than 100 holdings is a red flag.” Why is that?

Does the management style of the fund make a difference for concentrated funds? Would a passive, index-tracking ETF run into the same issues as an actively managed ETF?

Thematic ETFs are a popular example of concentrated portfolios with high active risk. How have they performed?

Do investors tend to miss the timing on thematic funds? It seems like strong returns tend to be short-lived.

At Morningstar, we often talk about fees as a predictor of performance. Do you see the same thing here?

Should investors always choose a fund that takes on predictable risk? Or are there cases where higher active risk is worth it?

What is one takeaway you have for investors that are trying to choose an ETF?

Read about topics from this episode.  

Subscribe to Morningstar’s ETFInvestor newsletter. 

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Daniel Sotiroff

Margaret Giles

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