About the U.S. News ETF Rankings


The U.S. News Best Fit ETF rankings are designed to help long-term investors evaluate and compare the structure of exchange-traded funds. Since all ETFs are intended to track an underlying index (for a variety of equities, or the price of a commodity, for example), we aim to identify large, liquid funds that perform reliably and could function well as part of an investor's long-term asset allocation plan. We also compare funds' costs, both those contained in commonly published expense ratios and implied by trading spreads, as well as a fund's level of diversification and success in tracking its index. We discuss each of these measures in depth below.

The Best Fit methodology is divided into two components. The first is how the Best Fit ETFs are selected. The second is how funds are compared and ranked.

Selecting Best Fit ETFs

To identify Best Fit ETFs, we set criteria that we believe should be of interest to everyday long-term investors; namely, a fund's longevity, size, and appropriateness for a traditional asset allocation plan.

Our Best Fit ETF rankings include funds with at least a one-year trading history and at least $100 million in assets under management, and exclude funds using leveraged or inverse strategies, as well as actively managed funds. Such funds are fine for more sophisticated traders, but not long-term, passive investors. Funds meeting all of these criteria are designated "Best Fit" funds and are eligible to be ranked.

Note that only exchange-traded funds, and not exchange-traded notes, are included in the Best Fit ETF ranking.

Ranking Best Fit ETFs

Best Fit funds are ranked within their categories, such as Small Cap Funds or Municipal Debt Funds. Categorization of funds is provided by Interactive Data Corp.

Best Fit funds are ranked by an overall score calculated from four component measures: a fund's expense ratio, tracking error, bid/ask ratio, and diversification. For each component measure, funds receive a score between 0 and 100, based on their performance on that measure in comparison to other funds. The top-scoring fund within a given measure (lowest expense ratio, for example) receives a score of 100 for that measure. The four component scores are then weighted (see below) to create an overall score. The overall score defines a fund's rank within its category.

Components measures and their weightings:

• Expense Ratio (30%)

• Tracking Error (30%)

• Bid/Ask Ratio (20%)

• Diversification (20%)

Funds without data for the components outlined above are excluded from our ranking.

About the Component Measures

1. Expense Ratio

What is it?

Expense ratio is the percentage of fund assets a fund manager may withdraw each year to pay for operating expenses.

Why is it important?

Lower expense ratios mean better returns for comparable ETFs.

How is it measured?

Data is for a fund's total annual expense ratio.

2. Tracking Error

What is it?

Tracking error is a measure of the volatility of excess returns relative to a benchmark. Excess returns are the investment's return in excess of its primary benchmark, which is based on a broad asset class. The tracking error is calculated for the past six-month period. Benchmark indices are provided by Morningstar.

Why is it important?

Tracking error tells investors whether the ETF they've purchased is actually following the performance of its underlying index.

How is it measured?

Tracking error is calculated by a linear regression of the ETF's daily net asset value returns on the underlying index's daily total returns for the past six months.

3. Bid/Ask Ratio

What is it?

The bid/ask ratio measures the spreads between bid and ask prices among various ETFs. It is calculated by dividing the bid price minus the ask price (the "spread") for a fund by the mid price between the bid and ask prices.

Why is it important?

Bid/ask spreads can measure "hidden" transaction costs for an ETF, as well as liquidity (higher bid-ask spreads imply lower liquidity).

How is it measured?

The bid/ask measure is calculated daily and based on a 30-day average of closing bid/ask spreads. Narrower spreads receive higher scores.