Use The Sharpe Ratio For Profits With These ETFs
The Sharpe ratio, a risk measurement and management tool named for Nobel laureate William F. Sharpe, is as easy to explain as it is important. At its core, the Sharpe Ratio tells investors whether a portfolio's success is due to savvy investment decisions or taking on unnecessary risk.
Calculated by subtracting the risk free rate – such as the returns offered by short-term Treasuries – from the rate of return for a portfolio and dividing the result by the standard deviation of the portfolio returns, according to Investopedia, the Share Ratio tells investors just how good a portfolio's risk-adjusted performance has been.
A high Sharpe Ratio indicates good risk-adjusted performance while a low Sharpe Ratio indicates investors would have been better off with a more conservative investment vehicle.
Since equity-based ETFs are baskets of stocks, or portfolios themselves, using the Sharpe Ratio to find winning funds makes sense. What follows just a few of the ETF this Sharpe Ratio screen. Screen parameters: Sharpe Ratio of 0.5 and higher, three-year total returns of at least 10 percent, expense ratio of below one percent and a beta against the S&P 500 of no higher than 1.5. Please note this screen was run on Zecco, which near as we could tell, offers one of the only free Sharpe Ratio screeners.
Vanguard Dividend Appreciation ETF (NYSE: VIG) The aforementioned screen turned up 230 and equity-based ETFs and perhaps not surprisingly, nearly 10 percent of that group hails from the Vanguard family. VIG is already the largest dividend ETF by assets, but that shallow metric does not indicate the fund's true worth to conservative investors, but the screen does.
VIG has an expense ratio of just 0.13 percent, making it less expensive than 88 percent of comparable funds, according to Vanguard. VIG's beta against the S&P 500 is just 0.82 percent and that does not come by virtue of an excessive weight to utilities names, a favorite beta-reducing trick of some ETFs. That sector accounts for just 1.8 percent of VIG's weight.
With a Sharpe Ratio 0.85, VIG has gained almost 11 percent in the past three years.
iShares MSCI Thailand Investable Market Index Fund (NYSE: THD) While the screen did not turn out to be heavy on emerging markets ETFs, the total number that met the criteria was decent and those funds that did make the cut offer investors exposure to both Asian and Latin American developing markets.
As is the case with VIG, THD's inclusion on this list probably is not a surprise to those that are familiar with the fund. The lone Thailand-specific ETF has been one of the best-performing ETFs of any type since the March 2009 market bottom. Fees of 0.6 percent mean THD comes cheaper than the comparable China fund.
THD's Sharpe Ratio, according to Zecco data, is 1.1, meaning it is double that of the Sharpe Ratio on the supposedly more conservative iShares MSCI South Korea Index Fund (NYSE: EWY).
First Trust NASDAQ-100 Equal Weighted Index (NASDAQ: QQEW) An underrated way of grabbing technology sector exposure while dodging single-stock risk QQEW has recently performed better than some marquee tech ETFs, such as the Technology Select Sector SPDR (NYSE: XLK).
However, there is more to QQEW's story. In addition to a solid Sharpe Ratio of 0.61, QQEW offers investors a low price/cash flow ratio of 11.08, according to First Trust data. That is relevant because securities with low price/cash flow ratios have a tendency to outperform those with high price/cash flow ratios.
Other ETFs that appeared in the screen with Sharpe Ratios above follow here with the Sharpe Ratios after the tickers: First Trust Morningstar Dividend Leaders Index Fund (NYSE: FDL) 1.2, iShares NASDAQ Biotechnology Index Fund (NASDAQ: IBB) 1.14, PowerShares Dynamic Cosnumer Discretionary Portfolio (NYSE: PSL), 1.1, Guggenheim S&P 500 Equal Weight Consumer Staples ETF (NYSE: RHS) 1.29 and the WisdomTree Dividend Ex-Financials Fund (NYSE: DTN) 1.21.
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