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We view ETFs primarily as instruments for asset allocation purposes. As such, a rigorous recommendation scheme will need to combine the outlook for the underlying industry or asset class with the specific attributes of the individual ETF. And that’s exactly what the Zacks ETF Rank does.
The Zacks ETF Rank provides a recommendation for the ETF in the context of our outlook for the underlying industry, sector, style box, or asset class. Our proprietary quantitative model takes into account a number of fundamental and technical factors about the ETF and the Zacks forecast for the underlying industry or asset class.
The methodology also takes into account the risk preferences of the investors and divides each set of ETFs following a similar investment strategy (style box/industry/asset class) into three risk categories- High, Medium, and Low. The aim of our models is to select the best ETFs within each risk category.
Zacks #1 Rank = Strong Buy
Zacks #2 Rank = Buy
Zacks #3 Rank = Hold
Zacks #4 Rank = Sell
Zacks #5 Rank = Strong Sell
As such, each ETF has a Zacks Rank and a measure of its associated risk. For example, an ETF may have a Zacks # 1 Rank and be deemed High Risk or it may be Zacks # 1 Rank and Low Risk, or any of the different Rank/Risk combinations. These risk categories reflect multiple fundamental factors, including expected price volatility.
We have ranks for U.S. Equity, U.S. Fixed Income—Treasury and Corporate Bonds, Currency, Commodity and International ETFs with a minimum six months’ of performance history.
Elements of the Zacks ETF Rank
Zacks Forecasts for Future Asset Class Returns
Zacks forecasts of asset class returns are an integral part of the Zacks ETF Rank. We have forecasts for
1) Equity returns for the broader U.S. equity market, large cap/small cap groups, value/growth groups and major market sectors
2) Equity returns for all geographic regions and 20 major countries outside of U.S.
3) Fixed income rates for U.S. treasury, mortgage and corporate bonds
4) Foreign exchange rates for all major currencies
5) Commodity rates (metals, energy and agricultural commodities)
These forecasts are available in the monthly Zacks Market Strategy report.
In making these forecasts, we rely on (a) Zacks proprietary models, (b) input from the Zacks investment committee comprised of senior investment professionals at the firm, (c) consultations with the Zacks consulting economists at Macroeconomic Advisors, and (d) carrying out a Zacks monthly survey of sell-side investment strategists and buy-side chief investment officers (CIO).
Expected Performance of the ETF Relative to its Industry/Asset Class*
Our quantitative models estimate the future performance of the individual ETFs relative to their industry/style box/asset class using past performance data.
Expense Ratio--expressed a percentage of the total assets--is the annual fee that the investors have to pay for the fund’s operating expenses.
Bid-Ask ratio--calculated as the difference between the bid and ask prices as a percentage of the ETF’s mid price--measures the implicit cost of trading an ETF. Bid-Ask Ratio is inversely related to the liquidity of the ETFs; hence the higher the liquidity, the lower the bid-ask ratio, resulting in lower trading costs for the investors.
We calculate momentum as the velocity of price change over the past three months. Momentum indicates relative price strength of a particular ETF within an asset class.
Duration is a measure of the sensitivity of the bonds to the changes in interest rates. Bonds’/Bond ETFs’ prices move inversely to the interest rates. Duration has to be taken into account in the context of our outlook for the interest rates.
Most bonds issued by the companies and sovereigns are analyzed and rated by the credit rating agencies. We use average credit rating for the bond ETFs as one of the factors in our analysis.
Dividend or coupon payouts made by an ETF need to be taken into account in calculating the total return for an ETF investor.
While we focus on the macro picture, we do not ignore the micro picture either. So “what’s inside of an ETF” is an important factor in many of our ETF ranks.
Arriving at the ETF Rank
Each ETF is assigned a score for each of the above factors and then total score is arrived at by adding the weighted scores of all factors, using the factor weights assigned by our proprietary ranking model. Total score is used to assign rating from #1 through #5 within an asset class.
Time-horizon of the ETF Ratings
The Zacks ETF Rank and Risk ratings have a time horizon of 6 months. However, we continually assess the ranks and ratings and update them every quarter.
Leveraged and Inverse ETF
We believe that leveraged and inverse ETFs are short term trading vehicles suitable for sophisticated investors only. Given the complexities of these instruments, investors need to be extra cautious in considering them for anything other short-term tactical reasons. We do not rank these securities.
Please visit Zacks Rank Home Page to screen ETFs by their ranks and other criteria.
*Only for US Equity ETFs
**Only for Fixed Income ETFs