3 New Funds Join the Kiplinger ETF 20

A few of the exchange-traded funds on our of the best ETFs for all investors don’t look as appealing as they did a year ago, so we’re swapping them for ETFs we find more attractive now.

For starters, we’re dropping Vanguard FTSE Emerging Markets (symbol VWO). Although developing markets should fare well over the long haul, we’re worried about the ETF’s rising exposure to Chinese stocks. The ETF has been adding China’s A shares (stocks that trade on mainland markets), and its China exposure is likely to hit almost 29% by year-end, up from 25% last year. Given the tumult in mainland markets, which fell 19% in the first half of 2016, the ETF is getting too China-centric for our taste.

More appealing, in our view, is Vanguard FTSE All-World ex-US Small-Cap (VSS), which we’re adding to the Kip ETF 20. Tracking an index of about 3,440 small- and medium-capitalization stocks, the ETF holds a diverse mix of companies in both developed and emerging markets. Small-cap stocks tend to be riskier than large caps. But this ETF hasn’t been much more volatile than its large-cap counterpart. And it has edged foreign large caps over the past three years by an average of 1.6 percentage points per year. The ETF’s annual expense ratio is a low 0.17%, and the fund sports a 2.8% dividend yield.

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In the core bond category, we’re swapping iShares iBonds March 2020 Term Corporate (IBDC) for iShares iBonds December 2021 Term Corporate (IBDM). Both ETFs hold hundreds of high-quality corporate bonds. But bonds in the incoming ETF all mature by December 2021—more than a year later than bonds in the outgoing fund. Because the new ETF holds longer-term bonds, it yields 2.3%, compared with 1.8% for the 2020 fund. Stick with the ETF until its termination date in 2021 and you should get back your initial investment, less annual fees of 0.10%.

Also in the bond world, we’re trading iShares J.P. Morgan USD Emerging Markets Bond (EMB) for iShares Mortgage Real Estate Capped (REM). The emerging-markets ETF has been a champ, returning 11% in the first half of 2016. But it yields 4.9% now—not enough to justify the considerable risks in emerging-markets debt.

Yielding a hefty 11.0%, the new ETF on our list holds real estate investment trusts that buy pools of mortgages and other types of real estate debt. Mortgage REITs borrow at short-term interest rates and use the proceeds to buy long-term debt.

The risk is that short-term rates could climb while long-term rates remain flat or edge down, raising financing costs and squeezing the firms’ profits. That has been happening a bit. But if the trend doesn’t accelerate, which we don’t think it will, the stocks should hold up, and the ETF should be able to maintain its quarterly payout of 30 cents per share.