Our ETF research team narrows the field to find the best core funds for your portfolio.
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By Scott Burns | 12-04-09 | 06:00 AM | Email Article

There are currently more than 900 different ETFs and ETNs available for U.S. investors. Although we on Morningstar's ETF research team revel in all of the different choices ETFs provide, we realize that finding the best funds for your most basic investing needs can be overwhelming. Even after using Morningstar.com's powerful ETF screening tool to look for something as simple as a mid-cap ETF, you will find more than nine choices from various providers, based on various indexes and with expense ratios ranging from 12 basis points to 38.

Scott Burns is director of global manager research for Morningstar.

As if all of the choices weren't confusing enough, picking the right ETF can be a complicated process that often requires making trade-offs regarding liquidity, expenses, and underlying index construction. There are tax issues to keep in mind for funds linked to commodities, and in terms of sectors, you need to decide whether it is worth paying up for international exposure.

Recognizing the challenges that investors face in making what should be simple investing decisions, Morningstar's ETF research team created the  ETF Analyst Picks list. This group of 35 ETFs and ETNs is our preferred list of funds across a variety of size, style, geographic, and sector equity themes. Likewise, we have representatives from the fixed-income and commodity broad asset classes. Our ETF Analyst Picks are available to Morningstar.com Premium Members. If you're not a Premium Member, you can still see our picks, access our 300-plus ETF Analyst Reports, and get research on more than 3,000 individual stocks and mutual funds by taking a free, 14-day trial membership.

To create this list, the Morningstar ETF research team looked at a number of factors such as expenses, index construction, liquidity, and diversification. As I mentioned before, sometimes the cheapest ETF is not the most liquid or the best constructed. Because there is no magic formula for how all of these factors should be prioritized, the final decision on whether to include a fund in the ETF Analyst Picks list is qualitative. As such, we have provided additional insight into why each fund made the cut in the  comments section of the picks list page.

For example, our pick for an S&P 500 tracking ETF is not the ubiquitous  SPDR  but rather the  iShares S&P 500 Index . While SPY is great if you need to trade $20 million on a moment's notice, the fund suffers some structural disadvantages that cause it to lag the S&P 500's returns over the long run. IVV on the other hand is a much newer product and has relieved itself from this structural defect. The difference is slight, but when you are investing in passive indexes over the long run, every basis point counts.  

Frequently Asked Questions:

Q: Are you saying that all of these ETFs are "buys"?

A: No, this is not a "buy" recommendation list. The purpose of this list is to highlight the best available options across a variety of categories regardless of the current price or investment prospects of those funds. The goal is to help investors narrow down the massive field of options in terms of the factors mentioned above.

Q: Should I buy all of the ETFs on this list at the same time?

A: No, you should not confuse the Analyst Picks List with a model portfolio. We do run a couple of model portfolios in our ETFInvestor Newsletter, but the purpose of this list is to highlight the best options across a variety of categories to help investors find topnotch ETFs to meet the specific needs of their own portfolios.

Q: Why are there several different options for some of the categories?

A: Even as we narrowed down the field, there were still a couple of areas where investors will need to make their own decisions between two very good funds. We carefully highlighted the differences between the options in our comments section.

Q: Where are the alternative, leverage, fundamental indexes and active ETFs?

A: This is kind of a trick question, because there are a few of these sprinkled throughout the list. Still, the Analyst Picks List is meant to present what we feel are the core holdings or building blocks for an investment portfolio. While there are plenty of quality funds that use sophisticated strategies or are more suitable for active traders, those ETFs require much more due diligence than this list can provide.

Q: What would trigger a change to the list?

A: If we think that a better option comes along than one already on the list, we will make a swap. Usually this happens when a cheaper alternative becomes liquid enough to meet our threshold.

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Disclosure: Morningstar licenses its indexes to certain ETF and ETN providers, including Barclays Global Investors (BGI), First Trust, and ELEMENTS, for use in exchange-traded funds and notes. These ETFs and ETNs are not sponsored, issued, or sold by Morningstar. Morningstar does not make any representation regarding the advisability of investing in ETFs or ETNs that are based on Morningstar indexes.

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