The third quarter’s in the books; it finished with a whimper rather than a bang. The S&P 500 lost 0.3% in the quarter’s final day of trading, ending up 0.6% in Q3, its seventh straight quarterly gain. Meanwhile smaller stocks, represented by the Russell 2000, lost 1.5% in the quarter, its worst result in three years.
So, what were the best ETFs in Q3?
The best performing non-inverse, unleveraged ETF in the third quarter was the Elements Spectrum Large Cap U.S. Sector Momentum Index ETN (EEH), up 83% over the three-month period. But before you run out and buy EEH, you might want to consider that this momentum play carries a great deal of volatility by overweighting the sub-indices outperforming the S&P 500 and underweighting the laggards. Trading at a 57% premium to net asset value, EEH can quickly reverse course. For this reason I’ll exclude it from my best ETFs of Q3.
September’s inflow for ETFs was $21 billion and $54 billion for the entire third quarter. Year-to-date investors have gobbled up $127 million in ETFs — the nine-month record of $160 billion was set in 2013 — making it entirely possible that they meet or exceed 2013’s record of $188 billion.
Here then are my three picks for best ETFs of Q3.
Best ETFs of Q3 – First Choice
Interestingly, although small-caps had a rough ride in the U.S. in third quarter, one of the best ETFs of any kind was the Deutsche X-trackers Harvest CSI 500 China A-Shares Small Cap ETF (ASHS), which gained 32.2% in Q3.
Chinese ETFs are gaining ground after the Chinese government expanded the total outstanding renminbi qualified foreign institutional investor (RQFII) quota to $62.2 billion in September. The ASHS invests in the A-Shares of 500 small-cap companies listed on the Shanghai and Shenzhen stock exchanges. The ETFs become so popular — $525 million in total net assets gathered in less than a year — Deutsche Bank’s been forced to negotiate with regulators to get its quotas increased.
With housing prices in China cooling off, the stock market has become the preferred investment of individual investors there. In addition, foreign investment is set to grow thanks to Shanghai-Hong Kong Stock Connect, the program that will bring together the two markets in an effort to open trading to foreigners. Given the Shanghai Composite has underperformed since 2010, these new initiatives portend good things to come.
Best ETFs of Q3 – Second Choice
Another region experiencing strong returns in Q3 is the Middle East, where a total of four ETFs delivered total returns higher than 10% over the three-month period. Of the group, two are more broadly based across the region — WisdomTree Middle East Dividend (GULF) and Market Vectors Gulf States (MES) — although even then they tend to focus on just three countries: United Arab Emirates, Qatar and Kuwait.
So, which of these do I consider to be the best ETFs of Q3? I’m going with WisdomTree’s fund for several reasons.
First, its expense ratio is 10 basis points cheaper than MES at 0.88% annually. Second, it’s much more liquid, with almost double the average daily volume over the past three months. Third, its 12-month yield is 2.26%, 61 basis points higher than Market Vectors’ ETF. Lastly, its performance over the past five years is more than three percentage points greater on an annual basis. Both of these ETFs are a bet on the Middle East financial services industry with weightings around 50% or more. Except for the first three points I’ve made they both should be considered among the best ETFs of Q3.
Best ETFs of Q3 – Third Choice
With my third and final choice I’m going with a sector play as one of the best ETFs of Q3.
No fewer than 20 health-related ETFs had positive returns in Q3, with some of the best results delivered in biotechnology. Of these I have to go with the First Trust NYSE Arca Biotech ETF (FBT), which produced a three-month total return of 11.5% according to Morningstar. Its three-year total return on an annual basis is an astounding 40.5%.
Who says biotechnology bets aren’t worth the risk?
In existence since June 2006, FBT has $1.5 billion in total net assets, making it the sixth-largest health-related ETF available. Charging 0.60% annually, the fund replicates the performance of the NYSE Arca Biotechnology Index, an index that’s equal dollar-weighted and invested in just 20 biotech companies. Each of the holdings is reset to a weighting of 5% on the third Friday in January, April, July and October.
On Sept. 29, Roche (RHHBY) completed its $8.2 billion deal for InterMune, which explains why First Trust’s materials show 19 holdings instead of 20. Come Oct. 17 the holdings will be reset to 5% and a new holding should be added. The deal also helps explain why biotech ETFs have done so well in the third quarter. Roche paid a 63% premium to the InterMune stock price immediately prior to the drug giant initiating takeover talks.
FBT is proof a single home run in a narrowly focused ETF is all that it takes to sufficiently juice a fund’s performance in order to make it one of the best ETFs in a given quarter. This time it just happens to be Q3.
As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.