Top 50 ETFs

Last year we turned to a panel of experts for the first time in order to fine tune our selection and this year we have used a similar process, combining data and qualitative expert input. This year’s larger panel is made up of:

■ Shaun Port, chief investment officer at Nutmeg

■ Lynn Hutchinson, assistant director at Charles Stanley Pan Asset

■ Adam Laird, passive investment manager at Hargreaves Lansdown

■ Alan Miller, chief investment officer and founder of SCM Direct

■ Ben Seager-Scott, director, investment strategy at TilneyBestinvest

■ Paul Taylor, chief executive officer at McCarthy Taylor

■ David Liddell, chief executive at IpsoFacto investor.com

■ Marco Aboav, ‎macro portfolio manager at MoneyFarm

■ Irene Bauer, partner at Twenty20 Investments

Starting out with our 2015 list we asked our panel:

a) to review the spread of categories and recommend any to be added or dropped and b) to consider the best indices for each category and recommend specific ETFs for those. We then analysed data on a wide range of ETFs tracking our chosen indices in order to isolate liquid, low-cost ETFs with the lowest tracking error and trading costs.

FE Trustnet provided us with fund size, tracking difference (the difference in ETF returns against benchmark) and ongoing charge data, as well as figures for tracking error (the volatility of ETF returns against the benchmark) across a wide range of funds. We have also taken into account the many articles we have written this year on a wide range of ETF topics and studied ETF data from FE Trustnet, Morningstar and Bloomberg.

Deciding on the final list was a delicate balance. It is important not to give too much weight to any one metric – for example the ETF with the lowest ongoing charge is not always cheapest and there is sometimes a good reason for poor tracking over a certain timeframe.

Oliver Clarke-Williams, head of FE Ratings, says: “Simply relying on quoted costs alone is not always indicative, as not all costs are always revealed by the funds, making comparisons difficult.

“Tracking error is a good indicator of how well a fund is tracking its respective index, but is not the be all and end all when looking at ETF performance. It’s important to take tracking difference, cost and fund size into consideration.”

This year we dropped the categories for private equity and property in order to focus on areas where passive ETFs really add value. Our panel felt that passive funds are excellent vehicles in highly efficient and expensive markets such as the US, whereas specialist areas such as private equity and property were areas in which active managers could add real value. ETFs tracking physical property indices also do not behave like physical property assets and so are not good diversifiers in the same way as bricks and mortar investments.

Last year we introduced currency hedging in several areas in order to minimise the impact of weakening foreign currencies on your returns. In many cases, the case for currency hedging is less clear than it was last year, when sterling was less volatile and with quantitative easing programmes weakening currencies in Japan and Europe. This year we have kept some hedged share classes, but for the most part have selected the most straightforward, sterling option. Bear in mind, however, that many ETFs are denominated in currencies other than sterling, which could have an impact on your returns.

For the full selection, split into easy-to-read sectors for desktop or tablet, click here.  

UK EQUITIES (FIVE ETFs)

These ETFs are designed as core portfolio building blocks and so we have included exposure to the main UK indices. However bear in mind that many investors tend to put too much focus on their home markets – they need to retain a balance of UK and overseas equities.

DROPPED FROM 2015 SELECTION:

■ iShares UK Dividend UCITS ETF (IUKD)

FTSE 100 dividends have been under pressure during 2015 and so this year we removed one dividend-focused ETF due to concerns over a lack of focus on dividend sustainability as well as dividend size. The iShares UK Dividend ETF was “part of a shrinking cohort of passive offerings that focus on the highest-yielding stocks with no ‘quality’ screens ensuring dividend sustainability”, according to Morningstar. It has also consistently lagged behind its benchmark by an amount greater than its fees, an indication of poor tracking quality.

iShares Core FTSE 100 UCITS ETF (ISF)

The range of products tracking the FTSE 100 is huge and, as such, price competition in this area has been fierce. iShares Core FTSE 100 UCITS ETF, part of iShares’ Core range, remains the lowest cost, with an ongoing charge of 0.07 per cent, and the majority of our panel felt it should be kept in the selection. Its tracking difference has not been as good as others tracking the same index, but with such a low cost and £3.7bn in assets it remains a compelling choice. The ETF uses physical replication and replaced the accumulating share class that iShares previously classed as its Core FTSE 100 product, meaning this option distributes income.

SPDR FTSE UK All Share UCITS ETF (FTAL)

The FTSE All-Share is another key index for UK investors, covering the combined universes of the FTSE 100, FTSE 250 and FTSE Small Cap indices. Because the index is large, made up of 639 stocks, the ETFs tracking this index do not hold all of the constituents and instead use physically optimised sampling to get as close as possible to the performance of the index. FTAL holds a representative sample based on correlations, exposure and risk. This is the cheapest ETF tracking the index in ongoing charge terms, with lower tracking error than comparable ETFs over the medium term.

NEW: db X-trackers FTSE 100 Equal weight UCITS ETF (DR) (XFEW)

Lynn Hutchinson, Alan Miller, Shaun Port and Adam Laird (pictured above) all suggested adding dB x-trackers FTSE 100 Equal Weight (DR) 1D (XFEW) as a way of offsetting the distortion inherent in the parent index towards the largest stocks. This ETF gives each stock in the index an equal weight of 1 per cent at the time of rebalancing and means that stocks are less skewed towards sectors like oil and gas. It is also a way to increase your exposure to companies further down the market cap scale. Shaun Port says it is a “size factor of sorts within a large-cap segment” and Adam Laird says it offers diversification as well as “real simplicity”. The ETF uses direct replication and is rebalanced semi-annually to coincide with the June and December adjustments in the FTSE index.

Vanguard FTSE 250 UCITS ETF (VMID)

This is the lowest-charge ETF tracking the FTSE 250 and one of the largest, making it highly liquid. It remains smaller than the comparable db X-trackers ETF we listed in this section in 2014, but has performed better over a year, with lower tracking error and tracking difference against the index.

SPDR S&P UK Dividend Aristocrats UCITS ETF (UKDV)

We have retained exposure to SPDR’s dividend-focused ETF due to its focus on sustainable dividends. The S&P UK High Yield Dividend Aristocrats index measures the performance of the 30 highest-yielding companies from the S&P UK Broad Market Index that have followed a policy of increasing or maintaining stable dividends for at least 10 consecutive years. The ETF aims to strike a balance between high yield and good dividend growth and excludes companies whose future dividend yield could be under threat.

The ETF remains relatively small in asset terms and is a concentrated fund, but has a longer track record than other, very new, UK income ETFs and is well balanced in sector terms. Shaun Port says it “remains attractive for buy-and-hold exposure”. It is a fully physically replicating ETF.

US EQUITIES (SEVEN ETFs)

The US is a popular area for passive investing because active managers have struggled to beat their benchmarks, making lower-cost passive funds that return the index a far more appealing proposition in many cases. As a result, we have beefed up this category for 2016 and broadened out the selection to include two new smart-beta ETFs, which weight stocks by measures other than market cap, and add a more active tilt to the selection while retaining a low price tag, and have maintained two income-focused ETFs.

DROPPED FROM 2015 SELECTION:

■ db X-trackers Russell 2000 UCITS ETC 1c (XRU2)

Note that last year’s db X-trackers Russell 2000 ETF no longer exists in its current form – it was wound into a new fund and is now listed under new code XRSG. Three of our panel reco mended switching into the lower-cost SPDR Russell 2000 US Small Cap (R2SC) instead.

NEW: SPDR Russell 2000 US Small Cap (R2SC)

Adam Laird, Alan Miller and Paul Taylor (pictured above) all prefer this to our former Russell 2000 ETF due to its low cost and tight tracking. The Russell 2000 tracks US small-caps and the SPDR ETF uses physical optimised sampling to gain exposure to these. With a 0.3 per cent ongoing charge it is cheaper than our former choice by a third. The Russell 2000 index gives you exposure to US smaller companies, which could experience faster growth than those in larger indices, although returns have historically been more volatile than for larger stocks.

PowerShares EQQQ Nasdaq 100 UCITS ETF (EQQQ)

The Nasdaq is the second largest exchange in the world and dominated by some of the world’s largest and most talked-about technology names, including Apple, Amazon and Facebook. The Nasdaq 100 tracks the performance of the 100 largest non-financial companies listed on the Nasdaq stock exchange and, according to Adam Laird, PowerShares EQQQ Nasdaq UCITS ETF “is the leading product in this major index”. The ETF is large and liquid, at a size of $1.14bn, and pays out quarterly dividends as well as offering good capital growth. Its ongoing charge is 0.30 per cent. Bear in mind that this index, and ETF, is heavily concentrated, with almost 30 per cent invested in Apple, Microsoft and Amazon.

Vanguard S&P 500 UCITS ETF (VUSA)

Last year we exchanged SPDR S&P 500 UCITS ETF (SPX5) for the lower-cost Vanguard ETF and our panel recommends holding on to it. It has tracked well, is large and liquid and remains among the lowest-cost options for access to 500 of the largest companies in the US. Since inception in 2012 its risk-adjusted returns have ranked it in the top quartile against similar passive and active funds, according to Morningstar. Over three years it has slightly outperformed its index due to dividend withholding tax differences between the fund and index.

NEW: UBS ETF - MSCI EMU Value UCITs ETF (UB17)

Tilting an index towards stocks with value characteristics has become one of the most popular ways for retail investors to make use of smart-beta ETF investing (in which stocks in an index are weighted by a factor other than market cap) and could be a good way to add alpha to your passive US exposure. Value stocks are thought to be on track to outperform this year following the first interest rate rise since 2006 last year and UBS MSCI USA Value UCITS ETF makes a good low-cost contrarian play on the market at an ongoing charge of 0.20 per cent. The index uses book value to price, 12-month forward earnings to price and dividend yield to weight stocks taken from those with a market cap within 80 per cent of the US investable equity universe and is recommended by Shaun Port.

NEW: PowerShares S&P 500 High Dividend Low Volatility UCITS ETF (HDLG)

Adam Laird and Lynn Hutchinson suggested we add this smart-beta ETF to the selection. It aims to capture high-dividend-paying stocks while also reducing volatility by tracking the S&P 500 Low Volatility High Dividend Index, which selects the 50 least volatile high-dividend-yielding stocks in the S&P 500 index, while retaining diversification, volatility and tradeability requirements. It is a fully physically replicating ETF and pays quarterly dividends – and in the short term has outpaced the returns of the S&P 500. Because it aims to minimise volatility, the ETF is unlikely to take part in upside rallies, but it should also lose less than broader ETFs in a downturn while also providing an income kicker.

S&P US Dividend Aristocrats UCITs ETF (USDV)

This ETF tracks the performance of companies within the S&P Composite 1500 that have sustainably increased dividends for the last 20 consecutive years. It has an ongoing charge of 0.35 per cent, is a physically replicating fund and has more than 100 holdings as well as a longer track record than comparable income-focused US ETFs. It had a historic yield of almost 2 per cent at the end of last year.

WisdomTree US SmallCap Dividend UCITS ETF (DESE)

It is hard to find income-focused small-cap strategies in the US with long track records and, of the choices, this remains the best according to our panel. WisdomTree US SmallCap Dividend ETF tracks the WisdomTree US SmallCap Dividend Index, which weights securities to reflect the share of aggregate cash dividends each component company is forecast to pay in the coming year, based on their most recently declared dividends per share – those projected to pay larger dividends are given a larger weighting in the index. It has 708 holdings and pays quarterly income. Adam Laird says: “I like the WisdomTree approach and the WisdomTree US SmallCap Dividend ETF has done well.”

COMMODITIES AND PRECIOUS METALS (FIVE ETFs)

This year, we decided to revamp the commodities category in order to move away from broad-based, synthetically replicating exchange traded commodities (ETCs) in favour of more targeted physically replicating funds. Physical ETCs do not incur the same trading costs as those that use derivatives contracts to track the price of commodities. Several of our experts felt that broad-based commodities ETCs were too dispersed to be of real value – agriculture stocks trade very differently to energy stocks, for example, and are likely to offer very mixed returns. Paul Taylor says: “With commodities, a broad brush may not be appropriate.”

This year we have opted instead for a high-risk ETC tracking the price of platinum, which has suffered several years of declines but looks well positioned for a reversal. We have also included an oil ETC in our list following its dramatic price slide in 2014 and recovery in early 2016. Finally we have included precious metals within this category to reflect the similar nature of gold, silver and industrial metal ETCs.

DROPPED FROM 2015 SELECTION:

■ Lyxor UCITS ETF Commodities Thomson Reuters/CoreCommodity (CRBL)

■ Source LGIM Commodity Composite UCITS ETF (LGCF)

■ Source LGIM Commodity Composite UCITS ETF (LGCF)

Source Physical Gold ETC (SGLD)

iShares Physical Gold ETC (SGLN) is now cheaper than Source Physical Gold ETC (SGLD) by four basis points (SGLD has an ongoing charge of 0.25 per cent), but the Source ETC is larger and more liquid with lower tracking error over five years and has a longer track record. The ETC provides the performance of the gold spot price through certificates collateralised with gold bullion. Each Gold P-ETC is a certificate backed by gold bullion held in JPMorgan Chase’s London vaults. Gold tends to make a good diversifier in a portfolio as it behaves differently to other asset classes and tends to rally while other assets are falling.

Source Physical Silver P-ETC (SSLV)

Silver is a precious metal, but has industrial uses, too, and has been surging in 2016 – up 14 per cent in the year to March. Like gold, silver can act as a hedge against inflation and contribute to a portfolio diversification strategy. This ETF tracks the spot silver price through certificates collateralised with silver bullion held in JPMorgan’s vaults and has a low ongoing charge of 0.39 per cent.

NEW: ETFS Physical Platinum (PHPT)

Industrial metals have been in a bear market for the past four years, but tightening supply and capex cuts, combined with higher demand for platinum and palladium in China and the US, is driving a recovery in the price of platinum. Platinum is also benefiting from new legislation targeting higher emissions standards for vehicles, as it is a key component used in emissions-cleaning catalytic converters for diesel cars. Almost 70 per cent of it is also used in industrial applications and car components and platinum loadings have increased along with the rollout of this new legislation. Meanwhile, mining cuts will contribute to a growing supply deficit. ETFS Physical Platinum is far larger and more liquid than its peers, with assets under management (AUM) of $360m, which makes it appealing despite its slightly higher charge, at 0.49 per cent compared with the lowest, at 0.39 per cent.

NEW: ETFS Physical Palladium (PHPD)

Of the physically replicating palladium ETFs listed in London this is by far the largest, with assets of over $190.9m. Like platinum, it is used in pollution-abatement equipment in the car industry – platinum tends to be used more in diesel-powered cars, while palladium is used in petrol cars. However, as more than 90 per cent of palladium is used for industrial applications and car components, its price is volatile. The ETC is backed by allocated metal held in a vault in Zurich and has an ongoing charge of 0.49 per cent.

NEW: ETFS WTI Crude Oil ETC (CRUD)

The oil price has been volatile from 2014 to 2016, first sliding to record lows in mid 2014 before rallying again at the start of 2016. Wherever you think the price will go from here, ETCs offer one of the most direct routes to the price of oil. While other funds tend to invest in the shares of oil-related companies, ETCs hold oil futures contracts. That brings extra costs and risk – if the futures price of oil is higher than the current price – but you are not betting on the fate of selected stocks as well as the price of oil. ETFS WTI Crude Oil ETC (CRUD) provides exposure to the price of US West Texas Intermediate (WTI) oil, extracted from US wells and sent via pipeline to Oklahoma. The US has seen a larger fall in rig counts during the oil price crash and less recent investment than other nations and so has a better capacity for price recovery and is also likely to benefit from the lifting on a ban on WTI oil exports. That means investors have flocked to this ETF recently, making it far larger than other oil ETCs, at over $8bn in assets.

JAPAN (THREE ETFs)

Japan is a major market and has undergone structural upheaval in recent years with the election of Prime Minister Shinzo Abe in 2012, who set in motion a major stimulus package aimed at boosting the economy. Last year, we introduced a currency-hedged ETF to protect investors against the rapidly falling yen, a process kick-started by a QE injection.

That case is now less clear cut, with the yen failing to continue weakening in recent months despite more stimulus. However we have left this option in the selection as a lower-risk choice for the region. We have also introduced a new ETF to give you exposure to a theme targeted by Mr Abe’s ‘third arrow’ of reform, the move to better corporate governance and shareholder returns, via the new Nikkei 400 index.

DROPPED FROM 2015 SELECTION:

■ Vanguard FTSE Japan UCITS ETF (VJPN)

■ iShares MSCI Japan Small Cap UCITS ETF (ISJP)

Our panel recommended switching the Vanguard ETF for iShares Core MSCI Japan IMI UCITS (IJPA) on the grounds that the index is broader and therefore a better core holding. Adam Laird also recommended dropping iShares MSCI Japan Small Cap UCITS ETF (ISJP), which is fairly expensive at 0.58 per cent. He says: “I’d rather opt for a global smaller companies ETF, which would need less monitoring.”

NEW: db X-trackers JPX Nikkei 400 UCITs ETF hedged to GBP (DR) 2D (XDNG)

Four of our panel recommended the addition of this ETF, which tracks the two-year-old index composed of companies with good shareholder values and corporate governance – a key focus of Prime Minister Abe’s recent reform efforts. Companies in the index are selected via a three-stage screening process. Stocks are first excluded if they were not listed in the past three years, have liabilities in excess of assets and have operating deficits over that period. The next two stages rank companies on their trading value over three years and size and identify those with the best return on equity, three-year reporting and disclosure standards.

Of the three members of our panel who opted for this index, two selected the hedged version in order to eradicate any currency risk (although you will miss out on returns if opting for hedged exposure if the yen strengthens). Of the two hedged products on the market, Lyxor’s currency hedging is managed more frequently (daily) compared with db X-trackers, which hedges on a monthly basis. However, three members of our panel selected db X-trackers’ ETF, which has an ongoing charge of 0.30 per cent. Lynn Hutchinson says: “I like this ETF for its diversification and index selection criteria for Japanese companies with good corporate governance. Japan’s Government Pension Investment Fund has also adopted this as its benchmark index.”

NEW: iShares Core MSCI Japan IMI UCITS ETF (IJPA)

This ETF tracks a wider index than our previous choice. Ben Seager-Scott says: “I favour the MSCI IMI Japan index, which covers a particularly wide investment universe while applying liquidity screens, ensuring the index is investable. Although such an exhaustive approach can provide challenges in certain markets, the Japanese equity market is generally liquid enough that such concerns are minimal for this particular market.” iShares Core MSCI Japan IMI UCITS ETF is the only ETF tracking this index, which uses sampled physical replication to track the performance of the 1,184 constituents making up the index (the FTSE Japan index tracked by our previous choice has 483 holdings) and has a low ongoing charge of 0.20 per cent. Adam Laird says: “This wider remit and greater small-cap coverage should help in the long run.”

UBS ETF - MSCI Japan 100% Hedged to GBP UCITS ETF (UC62)

This hedged ETF boasts the lowest fee in its peer group and has a “strong track record in physically replicating the exposure – it remains our primary route for hedged large-cap Japan equities”, says Shaun Port. The risk with hedging your exposure is one of opportunity cost – you could lose out on added return if the yen appreciates against sterling. But for a low-risk approach to investing in a country where the dominant policy has been one of monetary easing, we feel hedging still makes sense, particularly with an ongoing charge of 0.45 per cent.

EUROPE (FIVE ETFs)

Think carefully about the type of Europe index you want in your portfolio as there are important choices to make. You need to decide whether you want to strip out UK exposure entirely and invest in a Continental Europe or MSCI Europe ex UK ETF or whether to opt for the entire region. You will also need to choose between an ETF tracking the performance of only euro-denominated stocks or the entire universe. Hedging is also an issue here – it has been a successful trade amid the recent injection of monetary easing and might remain a safer place for risk-averse investors; however it is by no means certain that the euro will depreciate against sterling in the year ahead.

DROPPED FROM 2015 SELECTION:

■ iShares MSCI Europe Value Factor UCITS ETF (IEFV)

We switched this ETF for an alternative value-tilted eurozone fund that has a larger asset base, is more diversified and has outperformed in the shorter term.

db X-trackers Euro Stoxx 50 UCITS ETF (XESC)

This ETF gives you exposure to the 50 largest blue-chip countries in the eurozone. It is a physically replicating ETF with a low ongoing charge of 0.09 per cent and low tracking error and tracking difference over the short and longer term. Shaun Port highlighted the HSBC Euro Stoxx 50 UCITS ETF (H50E), which has cut its ongoing charge to 0.05 per cent, but as XESC remains much larger (so more liquid) and has a lower tracking error over three years we have retained this fund.

UBS MSCI EMU Hedged GBP UCITS ETF (UC60)

This remains one of the few hedged European equity ETFs and tracks a broader index than alternative hedged European ETFs and has performed well. The fund tracks the performance of 237 stocks within the 10 developed market countries in the European Monetary Union and sells euro forwards in order to hedge out the impact on returns from a falling euro against sterling.

Vanguard FTSE Developed Europe (VERX)

This remains the cheapest option for mid-to-large-cap Europe ex UK exposure and has tracked its benchmark well, partly due to its low ongoing charge. The ETF tracks the FTSE Developed ex UK index, a highly regarded market capitalisation weighted index comprised of 390 stocks from developed markets across Europe, excluding the UK. We considered switching to an ETF tracking the MSCI Europe ex UK index, but this index has fewer holdings and has not performed as well as the FTSE Developed Europe index over the long term.

NEW: UBS MSCI EMU Value UCITs ETF (UB17)

Value-style investing could be a good trade in the coming years in Europe as the recovery takes hold and a value-focused ETF is a good way of gaining access to this at a low cost. We previously suggested a Europe-wide value fund, but have exchanged this for UBS MSCI EMU Value UCITs ETF (UB17), which has no exposure to the UK or Switzerland. UK investors are likely to already have a large chunk of their portfolio in UK stocks and that makes this ETF, which is a physically replicating ETF invested in 122 constituents across 11 countries, a better bet. This ETF is also likely to capture a surge in positive sentiment for value stocks focused on the eurozone, as it is more specifically focused on this region.

WisdomTree Europe SmallCap Diviend (DFE)

This ETF has performed strongly and delivered a good income at a low cost and remains a compelling option for income from small-cap European stocks, which have good growth potential. The index selects stocks based on annual cash dividends paid as opposed to yield – a method designed to screen out stocks with unsustainable dividends as a ratio of their share price. It has generated a higher income over the short term than comparable income ETFs focused on mid- and large-caps, as well as impressive capital returns. With an ongoing charge of 0.38 per cent it is not the cheapest income ETF, but its growth and income has justified that. Alan Miller says: “The current gross dividend yield of the stocks within the fund is 3.9 per cent and the growth rate is about 8.3 per cent.”

EMERGING MARKETS (FIVE ETFs)

Emerging markets are a high-risk area, but can offer high growth in rising markets. The funds in this category are designed to give you optimum and broad exposure to the most exciting opportunities. This year, we have also broken China out into a new category to reflect the wide range of options in that market and the high interest in China-specific ETFs throughout the year.

DROPPED FROM 2015 SELECTION:

■ HSBC MSCI Russia Capped UCITS ETF (HRUB)

We have decided to remove the Russia ETF from last year’s list as it is a very-high risk market with less to recommend it than other country-specific emerging markets ETFs. Investors keen to have exposure to Russia can achieve this via a broad emerging markets index.

iShares Core MSCI Emerging Markets ETF (EMIM)

This is the only ETF tracking the MSCI Emerging markets IMI index and offers good low-cost exposure to a broader range of comparable emerging markets ETFs. Shaun Port (pictured above) says: “This remains an exceptionally strong route to market with broad emerging markets exposure. It is low-cost relative to other strategies, highly liquid and, as it tracks the IMI index, includes exposure to large, medium and small-cap stocks. The index is concentrated in China, South Korea and Taiwan. Alan Miller prefers the MSCI Emerging Markets indices to the FTSE Emerging Markets indices, which exclude South Korea and Samsung. However one key factor to bear in mind is MSCI’s upcoming decision on whether or not to include China domestic shares in its indices. If this goes ahead next month and you do not want exposure to relatively volatile domestic A shares, or already have onshore Chinese exposure, FTSE’s indices, which are separated into those including A shares and those excluding A shares might be a better bet for you. Vanguard FTSE Emerging Markets UCITS ETF (VFEM) is a good, low-cost option tracking the FTSE Emerging Markets index.

iShares MSCI Emerging Markets Minimum Volatility UCITS ETF (EMV)

This ETF aims to reduce the volatility of investing in emerging markets stocks by selecting the stocks from the parent index with the lowest absolute volatility of returns, subject to risk diversification. It has performed well over the long term, protecting investors against the losses incurred on the parent emerging market index without lagging far behind the parent index in rising markets. This ETF is lower-cost than comparable strategies, with an ongoing charge of 0.40 per cent, and has tracked well.

SPDR MSCI Emerging Markets Small Cap UCITS ETF (EMSM)

Of the two ETFs tracking this small-cap index SPDR remains the lowest cost and has a better tracking record over the long term, meaning it remains the best option, despite being smaller in terms of assets. The ETF has on ongoing charge of 0.55 per cent and uses sampled physical replication to track the index of over 1,800 stocks. The index is likely to give you good exposure to high-risk but fast-growing nations such as Taiwan, South Korea and India, which account for a large chunk of holdings. China also makes up more than 20 per cent of this index.

HSBC MSCI Brazil ETF (HBRL)

This tracks the performance of MSCI Brazil and, although no longer the cheapest in terms of ongoing charge, remains larger and more liquid than its competitors, making it cheaper overall when trading costs are taken into account. Brazil is likely to be a market to watch as political change in the region opens up potential for a shift in sentiment towards beaten-up Brazilian stocks.

db X-trackers MSCI India index UCITS ETF 1C (XCX5)

This index tracks the MSCI India total return index, which is strongly weighted towards information technology and financials. There are not many ETFs tracking this index and this is one of the best value options. This is not a physical ETF and uses swap contracts to replicate the index, adding an element of counterparty risk – however there are no physical ETFs in this area.

CORPORATE BONDS (FIVE ETFs)

We have overhauled this section in 2016 to reflect the growing popularity of and innovation in fixed-income ETFs and to include better core and more targeted offerings in high-yield and investment-grade credit, which could reduce your trading costs. We have reduced our exposure to very short-dated bonds, which we feel are well represented by our current selection, and replaced that holding with a core sterling corporate bond holding, which will give you diversified access to the asset class.

In the high-risk high-yield sector we have also replaced a global high-yield ETF with two ETFs targeting the US and European high-yield market separately. This reflects the fact that those markets have very different dynamics – with the US more concentrated in energy-related debt than the European high-yield market – and the fact that investors are able to reduce the spreads on trading by using different ETFs in each market.

Bear in mind that this market remains very high-risk and, although the yields on these ETFs are higher, that is due to the increased risk

associated with below-investment-grade debt and that ETF indices are weighted most heavily towards the largest issuers, so the most indebted companies or countries.

DROPPED FROM 2015 SELECTION:

■ iShares Ultrashort Bond UCITS ETF (ERNS)

■ iShares Global High Yield Corporate Bond GBP Hedged (GHYS)

iShares £ Corporate Bond 0-5yr UCITS ETF (IS15)

This bond ETF formerly tracked the Markit iBoxx £ Corporates 1-5 index, but now tracks the performance of shorter-dated bonds via the Markit iBoxx £ Corporate 0-5 index. The index tracks sterling-denominated investment-grade bonds with an expected remaining time to maturity of 0-5 years. The index change makes the ETF even less vulnerable to value erosion should interest rates rise. It uses sampled physical replication to track the 260 holdings in the index. The majority of bonds held are BBB-rated, but almost 50 per cent are held in AA and A-rated stocks combined and it has an ongoing charge of just 0.20 per cent.

NEW: iShares Core £ Corporate Bond UCITS ETF (SLXX)

Our panel recommended that, as well as shorter-dated sterling bond exposure, we broaden our selection to include a core bond ETF. This ETF tracks the Markit iBoxx GBP Liquid Corporates Large Cap index. Ben Seager-Scott says: “Given that corporate bonds are less liquid than equities or government bonds, it makes sense to use an index that specifically focuses on the more liquid end of the market.” This ETF, which at £1.6bn is far larger than its peers, is a good building block for exposure to UK corporate bonds. It has around a 30 per cent stake in financial versus non-financial issuers and is more weighted towards longer-duration bonds than IS15, with an effective duration of 8.75 years.

iShares Global Corporate Bond UCITS (CRPS)

This ETF tracks the performance of the Barclays Global Aggregate Corporate Bond index, which is a global index of corporate bonds issued by corporations in emerging and developed markets with a minimum maturity of one year. The index is a measure of investment-grade debt from 24 local currency markets, but the base currency is dollars, meaning there is exchange rate risk. The ongoing charge is 0.20 per cent.

NEW: iShares Euro High Yield Corporate Bond UCITS ETF (SHYG)

According to Morningstar, “this exchange traded fund is the market leader for this exposure”. Of the few euro high-yield bond ETFs listed on the London Stock Exchange it is by far the largest and most liquid, with assets of over E5bn and, over the long term, its tracking has been very tight, partly reflecting the fact that it engages in securities lending. The fund has a reasonably short effective duration of 3.09 years, meaning its value is less likely to be eroded by future interest rate rises in the UK, and it has a dividend yield of 4.4 per cent. Over 60 per cent of the bonds tracked are BB and over 30 per cent of assets are in B-rated debt. European high-yield is currently subject to different market dynamics than US high-yield due to the European Central Bank’s bond buying programme and has rallied significantly since the start of 2016.

NEW: PIMCO Short-Term High Yield Corporate Bond Index Source UCITS ETF (STHY)

Shaun Port suggests buying US and European high-yield exposure separately for better spreads. The European and US high-yield markets are very different, with the US more dominated by energy-related debt. Mr Port says: “STHY provides exposure to shorter-duration high-yield issues and while the expense ratio is high at 0.55 per cent, lower spreads relative to other products mean that it performs strongly from a total cost of ownership perspective.” This is a dollar-denominated share class and unhedged, so you will take on interest rate risk, and it is higher risk than other investments – although its short duration makes it less vulnerable to interest rate movements, which will be a boon when the US raises interest rates again. It has 343 bond holdings altogether.

GOVERNMENT BONDS (FIVE ETFs)

Government bonds are not offering high returns at the moment, with low interest rates pushing down yields. However this is a core portfolio area. This year, we have switched away from hedging with one suggestion and introduced a new smart-beta index for emerging market bond coverage.

DROPPED FROM 2015 SELECTION:

■ Vanguard UK Government Bond UCITs ETF (VGOV)

■ iShares JPMorgan $ Emerging markets Bond UCITS ETF (SEMB)

■ db X-trackers II Global Sovereign UCITs ETF 2D (GBP Hedged) (XGSG)

This is no longer the price leader and so we have replaced it with Lyxor iBoxx GBP Gilts ETF

NEW: Lyxor iBoxx £ Gilts ETF (GILS)

We have replaced our former Vanguard GILT ETF with Lyxor’s iBoxx ETF after Lyxor cut its ongoing charge to 0.07 per cent, making it far cheaper than Vanguard at 0.12 per cent, and changed its replication method from synthetic to physical. Adam Laird, Lynn Hutchinson and Shaun Port all suggested the switch. The index on the ETF is set to change from Markit iBoxx £ Gilts index to the more popular FTSE Actuaries UK Conventional Gilts All Stocks index, which will account for around 4 per cent of the bonds changing. Several panel members said this was their favoured index for UK gilts. The ETF is smaller than our former choice at around £31m, but Mr Hutchinson says: “That is fine as long as trading spreads are fine too, and spreads are around 20 basis points, which is similar to Vanguard.”

SPDR Barclays 1-5 yr Gilts (GLTS)

This remains the lowest-cost ETF tracking shorter-dated UK gilts and has a similar distribution yield to the iShares product tracking 0-5 year gilts. Unlike other ETFs tracking short-dated government bonds, this ETF is physically replicating, meaning it holds the 12 bonds in the Barclays UK Gilt 1-5 Year Index. It does not engage in securities lending and has tracked its index well, meaning we saw no need to remove it from the selection this year.

iShares £ Index linked Gilts UCITS ETF (INXG)

Index-linked gilts, unlike other bonds, protect you from inflation as their returns are linked to the rate of inflation. Although UK inflation remains low, the Bank of England’s target is to raise inflation and keeping some inflation protection in your portfolio is important. This ETF is not the cheapest on offer in terms of its ongoing charge, but it is one of the largest and so is more liquid by some margin. Bear in mind that it does engage in securities lending, but that reduces the impact of its charges. This ETF will not offer good returns in the short term and has a long duration, but will protect you if inflation does tick up.

NEW: iShares Global Government Bonds UCITs ETF (IGLO)

Adam Laird says: “Last time we switched iShares Global Government Bonds UCITs ETF (IGLO) for db X-trackers II Global Sovereign UCITS ETF 2D (GBP HEDGED) (XGSG) because of the hedging. I’d argue for switching back. It all comes down to why you would hold global bonds in the first place. If you want the higher interest rate overseas then buy the hedged XGSG, but rates are not higher overseas – gilts are yielding better than many of the other countries in the index.” This ETF, with an ongoing charge of 0.20 per cent, offers exposure to the aggregate performance of the government bond market of the G7 countries and has tracked the index well. It is dollar denominated and distributes income on a semi-annual basis.

NEW: Lombard Odier IM Emerging Market Local Government Bond Fundamental GO UCITS ETF (LOCG)

This is one of an interesting new range of smart-beta ETFs aimed at tackling the key issues with bond ETF investing – the fact that the most indebted issuers make up the largest weighting in the index. Emerging markets are a particularly risky area when it comes to bond buying and several members of our panel recommended using this new strategy from Lombard Odier and ETF Securities to combat this. Instead of the traditional market cap weighting, Lombard Odier has put together an index that screens for issuer creditworthiness and aims to identify those nations best able to pay back their debt. Lombard Odier uses a three-step approach to take into account macro factors such as current indebtedness, size of revenues and social and political stability and then weights the bonds in its index by liquidity and yield. Lynn Hutchinson says: “Although this ETF sounds expensive, this is about standards.” This is a new strategy and, although it has grown in assets in a short amount of time, remains smaller than a traditional market-cap ETF and so is likely to have higher spreads. However, this is an interesting buy-and-hold play on this market and could insulate you against the most dramatic swings in emerging market debt.

ASIA (THREE ETFs)

Asia encompasses a wide range of countries, markets and companies, so ETFs tracking this region vary widely. Many Asia indices just track developed markets, meaning you could end up with 60 per cent in Australia, while other indices are more skewed towards emerging Asian markets such as China, Thailand, Malaysia and the Philippines. This year, we removed one of the income-focused ETFs in favour of a broader core Asian equities holding.

DROPPED FROM 2015 SELECTION:

■ SPDR S&P Pan Asia Dividend Aristocrats UIT SETF (PADV)

NEW: Vanguard FTSE Developed Asia ex Japan UCITS ETF (VAPX)

This Vanguard ETF gives low-cost core exposure to this region and has an ongoing charge of 0.22 per cent. It is the only London-listed ETF tracking the FTSE Developed Asia Pacific ex Japan index which, unlike the MSCI AC Asia Pacific ex Japan or MSCI Pacific ex Japan index, includes exposure to Korea. The index is still heavily weighted to Australia, with over 42 per cent of its assets invested here, but less so than the main MSCI index, which has 60 per cent allocated to this region. It has wide coverage, physically tracking the performance of 366 holdings as opposed to fewer than 200 in the MSCI Asia Pacific ex Japan index and works well as a diversified Asian building-block ETF.

dB x-trackers MSCI AC Asia Ex Japan High dividend Yield Index UCITS ETF 1D (XAHG)

This is an income-focused ETF that screens out stocks with unsustainable dividends, but retains those with a higher-than-average dividend yield compared to the MSCI AC Asia ex Japan index. It includes large and mid-cap stocks across two or three developed market countries and eight emerging market countries in Asia, seeking equities with higher dividend income and quality characteristics than average, but screens for stocks with potentially deteriorating fundamentals that could lead to dividend cuts. At the end of April its dividend yield stood at almost 5 per cent. It is synthetically replicating and is not cheap, with an ongoing charge of 0.65 per cent. But its broad range of holdings compared with similar products and the fact it focuses on dividend growth and sustainability means it could be worth paying extra for.

iShares MSCI AC Far East ex-Japan SmallCap UCITS ETF GBP (ISFE)

This ETF tracks the performance of the MSCI AC Far East ex Japan Small Cap Index as closely as possible by physically holding equities. It is the only small-cap listed ETF in London and, although the index has not performed well, it could make a good buy-and-hold choice for long-term growth. Alan Miller recommends the fund, saying: “The iShares ETF is invested in 1,146 small companies that are currently growing at 13 per cent a year, but currently are valued at just 12.6 times earnings. It does have a high charge of 0.74 per cent, though.”

GLOBAL EQUITIES (FIVE ETFs)

This year we have dropped two smart-beta global equity ETFs which came with a higher price tag than more straightforward funds. Our panel felt these were overly complex for private investors and had not proved themselves in performance terms. We have added a small-cap ETF and a minimum volatility ETF, as well as switching our dividend-focused ETzF for one with a higher price tag but better tracking record and better long-term performance.

DROPPED FROM 2015 SELECTION:

■ Amundi Global Equity Multi Smart Allocation Scientific Beta UCITS ETF (SMRP)

■ Powershares FTSE Rafi All World 3000 UCITS ETF (PSRW)

■ iShares Core MSCI World UCITS ETF (SWDA)

PowerShares FTSE Rafi All World 3000 index has not outperformed the All World index on a cumulative or discrete annual basis, making it hard to justify the extra 0.25 per cent on this smart-beta ETF against a plain vanilla world equity option. Adam Laird says: “I am not yet convinced enough by the Rafi process to pay 0.5 per cent for this global ETF.” We also felt Amundi’s strategy was too confusing. In the place of these ETFs we have included a minimum-volatility ETF that has demonstrated impressive returns against the benchmark and a small-cap ETF.

Vanguard FTSE All-World ETF (VWRL)

The FTSE All-World index is one of the few truly global indices as it includes stocks from emerging markets as well as developed markets and includes a very wide range of stocks and countries as a result. The index comprises more than 3,000 constituents from nations ranging from Australia to Pakistan and has returned better results over the long term than the MSCI World index. Vanguard FTSE All-World ETF is one of two sampled physically replicating ETFs tracking the index and is low-cost, at 0.25 per cent. Alan Miller suggests this ETF and says: “The advantage of the FTSE World index is that it represents the performance of the large and mid-cap stocks from the developed and ‘advanced emerging’ countries.” Bear in mind that this index does not exclude the UK, which accounts for just under 7 per cent.

NEW: HSBC MSCI World ETF (HMWO)

HSBC MSCI World ETF recently cut its fee to 0.15 per cent, making it the clear market leader in price for ETFs tracking this index focused on 1,644 stocks from 23 developed countries, including the UK. The index is less ‘global’ than the comparative FTSE index as it excludes frontier and developing market stocks, but makes a good core holding for a portfolio and is likely to be better suited to investors with a lower risk tolerance. HMWD is still far smaller in terms of assets than our previous choice, the iShares Core MSCI World UCITs ETF (SWDA), but spreads are tight enough to make this a worthwhile switch and over time it is likely to grow in size. This is a physically optimised ETF and takes dollars as its base currency.

NEW: db X-trackers Stoxx Global Select Dividend 100 UCITS ETF (XGSD)

This year we have switched back into db X-trackers Stoxx Global Select Dividend 100 UCITs ETF (XGSD) from Vanguard FTSE All-World High Dividend Yield UCITs ETF (VHYL) despite its higher ongoing charge. Over the long term, XGSD has delivered high positive returns against a negative return for VHYL, has generated greater income and tracks an index with greater focus on the sustainability of dividends than our previous choice. db X-trackers also has a longer track record and over five years has returned a strong positive result, showing both positive income and capital growth. In the short term, however, the ETF has not delivered positive results and may be volatile. The ETF tracks the STOXX Global Select Dividend 100 Return Index, which measures the performance of the highest dividend-paying stocks from the Americas, Europe and Asia Pacific regions, with 40 holdings for the Americas and 30 each for Europe and Asia Pacific. Stocks are also screened for dividend per share growth and must have a dividend to earnings-per-share (EPS) ratio of less than or equal to 60 per cent or 80 per cent, depending on the region, to ensure income sustainability.

NEW: SPDR MSCI World Small cap UCITS ETF (WOSC)

Adam Laird suggests adding a small-cap ETF to the mix, saying: “Few investors want to spend time picking individual global small-cap regional ETFs. SPDR MSCI World Small Cap UCITS ETF holds almost 2,000 stocks and its fee is 0.45 per cent.” The fund is heavily weighted towards the US, where more than 55 per cent of assets are correlated, but is well diversified by sector.

NEW: iShares MSCI World Minimum Volatility (MVOL)

This ETF tracks the performance of the MSCI World Minimum Volatility index, designed to give you the returns of the parent index with less volatility. The index selects stocks from the MSCI World based on estimated risk profile and expected volatility, as well as the correlation between index constituents. The ETF aims to minimise downside losses, so it has actually generated far higher returns over the medium term than the MSCI World since launch, and has held up during the market falls early this year. It is also low-cost, at 0.30 per cent. Paul Taylor suggests this ETF and says: “The ETF has not only delivered in providing low volatility in a cost-efficient way, but has also performed remarkably well and stood up during the latest market tribulations.” It has 284 holdings and is a physically replicating fund.

CHINA (TWO ETFs)

Due to the scale of the Chinese equity market and the wide – and at first glance, confusing – range of indices, share types and ETFs focused on this area, we have decided to include China as its own category this year. As well as keeping our current choice for domestic Chinese equities – A shares – we have included a new ETF to track offshore-listed Chinese equities, which are likely to be less volatile than domestic shares while also offering exposure to the region. The A share market is dominated by Chinese retail investors and can soar ahead in good times, but it is also highly volatile and saw major market crashes in 2015. Hong-Kong-listed equities are by no means insulated from market falls, but will be a less risky bet when times are tough. Many investors are likely to already have exposure through an emerging markets or Asia Pacific fund, so check you are not overexposing to China if you do choose to invest in the region specifically.

iShares MSCI China A (IASH)

This ETF tracks the performance of the MSCI China A Index, made up of 807 China A shares listed on the Shanghai and Shenzhen stock exchanges, and is a physically replicating fund. It is larger and more liquid than comparable ETFs and has tracked well. This index is broader than the other popular A shares index, the CSI 300, and this ETF has an ongoing charge of 0.65 per cent.

NEW: db X-trackers FTSE China 50 UCITs ETF (XX25)

The FTSE China 50 index tracks the performance of the 50 largest Chinese stocks listed on the Hong Kong exchange and this is the lowest-cost ETF tracking the index, at 0.60 per cent. It has also tracked better than the comparable iShares product. Ben Seager-Scott (pictured above) says of this index: “The advantage here is that you are able to access what are essentially Chinese equities, but with a potentially higher level of confidence that comes from investing through a developed markets stock exchange in an established trading centre.” Although not exposed to the same swings as the A share market, this ETF remains very high-risk due to its concentration in a small number of stocks and sectors – more than half of its assets are held in the top 10 holdings and it is heavily skewed towards financials, making up almost 50 per cent of the ETF. Ben Seager-Scott says: “Investors will generally have significant exposure to Chinese banks and also state-owned enterprises, which are not always run in the interests of minority shareholders, so investing in China is a high-risk area.”