It is said that imitation is the sincerest form of flattery, and in the ETF world there is plenty of imitation. You can be certain whenever a new successful ETF is launched that a new version will soon follow. This epidemic of imitation is rampant on Wall Street, with firms releasing imitations that typically have a new feature or gimmick or are just a straight copy of an original, something attempting to capitalize on another firm’s success. While competition can be good for investors by driving down costs and/or providing more choice, it sometimes results in more confusion, and many advisors simply default to using the fund with the most effective marketing strategy.

When choosing an ETF to buy for a portfolio, it is important to look not only at the methodology of the fund but also at the team behind it. While it is tempting to just select the fund that has the brand name behind it, the most assets, the longest trading history or the lowest expense ratio, it may not necessarily be the best designed. At Exchange Traded Concepts, we tend to work with teams who bring expertise in the field and want to launch a fund. These tend to be people who have developed an expertise by being intensely focused on a specific sector or theme. In some cases, they might be a research organization looking for a way to monetize their research and who feel the current ETF marketplace lacks this particular type of product.

The importance of the expert approach is just as valid in index-based products as it is in actively managed funds. The design of the index parameters will ultimately determine the fund composition as new securities are added or removed. Experts are better positioned to understand the drivers for companies that are growing or expanding into a particular theme. Equally important to security selection is the weighting methodology. The weighting of individual securities inside the index and fund will have a drastic impact on performance, volatility and exposure.

In that vein, another consideration is the name of the fund itself. Fund names are regulated by the SEC under rule 35d-1, also known as the “Names Rule.” The easiest way to think about this rule is that 80% of the holdings of a fund must derive more than 50% of their revenue from the industry or theme specified in the name of the fund. The most recent example of the SEC enforcing this rule on the ETF community is the current handful of ETFs that invest in the blockchain theme. Because of the limited number of publicly traded companies that make most of their revenue directly from blockchain, the SEC contacted all the firms that had new funds on file in this space and forbade them from using blockchain in the funds’ names. This led to some rather creative fund names: Innovation Shares NextGen Protocol ETF (KOIN); Amplify Transformational Data Sharing ETF (BLOK); Reality Shares Nasdaq NexGen Economy ETF (BLCN) and First Trust Indxx Innovative Transaction & Process ETF (LEGR). While the SEC is well intentioned in its defense of shareholders, the unintended consequence can be that these fund names become very complex and may not describe the fund clearly as the issuers struggle to convey the funds’ intended exposure while complying with the Names Rule.

Before choosing an ETF to provide specific exposure for a client’s portfolio, spend a few minutes on the fund’s website. Read the offering documents to learn about the creation of the fund and the team behind it, and make sure you understand the exact exposure the product provides regardless of its name. While a fund’s expense ratio is important and many investors see a higher AUM number as validation for a fund, there may be a less obvious but better option out there.        

J. Garrett Stevens is CEO of Exchange Traded Concepts, a private-label ETF advisor whose turnkey platform enables people to launch their own funds.