Advisors favor quality and value ETFs as leverage risks build

Wealth advisors are tilting client portfolios toward quality- and value-focused ETFs as they watch leverage build up beneath an otherwise strong US economy in 2026. Even with corporate earnings holding up, several advisors say borrowing tied to artificial intelligence infrastructure and cracks surfacing in the private credit market are early warning signs worth positioning around.

“The backdrop is that even though the economy is charging ahead and the earnings season has been strong, there is still a lot of leverage that is being built into the system,” says Anna Rathbun, founder and chief executive of Grenadilla Advisory. “We can see this through headlines for AI-related borrowing as well as the deals that fall through in the private credit market.”

LEVERAGE CONCERNS PUSH ADVISORS TOWARD QUALITY AND VALUE

Rathbun says that as risk builds in the system, it can make sense to lean portfolios toward factors that have historically held up better when investor sentiment turns.

“As risks build into the system, it may be wise to lean the portfolio toward quality and value,” Rathbun says. “Don’t bet the farm on it, but understand that these positions have traditionally done better when fear creeps into market sentiment.”

Her preferred vehicles for that tilt are the Vanguard Quality Factor ETF (VFQY) for broad-market quality exposure and the Vanguard US Value Factor ETF (VFVA) for value.

DIVERSIFICATION INTO SMALL CAPS AND NON-US STOCKS PAYS OFF

Not every advisor is framing 2026 around defense. Jeffrey Ingraham, managing director and head of portfolio strategy at EP Wealth Advisors, says this year has finally rewarded clients who stayed diversified beyond US large-cap stocks.

“Diversification in equity portfolios has finally paid off this year as non-US equities and US small-cap equities have outperformed US large cap for the first time in a long while,” Ingraham says. “While this may not necessarily be considered the ‘hottest’ trade in markets right now from a flows or maximum return perspective, it’s nice to see investors who have a longer-term perspective be rewarded for their patience and discipline.”

Ingraham says his firm allocates to the Vanguard Small Cap Growth ETF (VBK) and the Dimensional US Targeted Value ETF (DFAT) within US small caps. For non-US exposure, he points to the iShares Core MSCI Emerging Markets ETF (IEMG), citing the importance of understanding how a country is classified.

“It’s important to note the distinction in which countries are classified as developed versus emerging, as we’ve seen that can potentially have a huge impact on returns this year with South Korea,” he says. “We allocate to the iShares Core MSCI Emerging Markets ETF, which provides the broadest exposure to EM from both a country and market cap perspective.”

LEVERAGED AND THINLY TRADED ETFS DRAW THE SHARPEST WARNINGS

Both Rathbun and Ingraham single out leveraged and single-stock ETFs as products to avoid, echoing scrutiny the products have drawn from regulators, including a recent SEC warning over plans for higher-leverage ETF products.

“Any leveraged and single-theme products, such as 3x levered index funds (like SOXL among others) and the newer single-stock leverage ETFs” should generally be avoided, Rathbun says. “I know it can be tempting when the market runs upward and you want to ‘juice’ your returns, but these leveraged instruments do not work the way one might assume.”

The daily-reset mechanics of these leveraged ETFs mean that volatility decay works against you – the underlying index can go up but you might still lose money. If the underlying index is up 5 percent over time, you won’t necessarily see 15 percent gain. You might have lost money depending on how the market moved in the interim.”

Rathbun also flags newer, low-asset thematic launches as a closure risk. “A fund that screens well on trailing performance or is started by a star analyst/manager but only holds $50 million ... means that you are exposed to real closure risk,” she says. “If the fund closes due to low AUM and the theme runs out of fashion, you will realize all the gains even if you do not make the decision to sell, and you’ll suddenly have a lot of taxable gains on your hands ... product proliferation, especially of leveraged products, tells me that we may be heading into the late-cycle market dynamics.”

Ingraham is similarly direct. “We’ve observed the significant increase in leveraged ETFs over the past several years – both index-based and single stock – but caution our clients against utilizing these strategies,” he says. “The leveraged daily return aspect from these strategies introduces a volatility decay and sequence of returns risk that is often misunderstood by investors and doesn’t fit with our goals-based, long-term investment philosophy.”

CORE HOLDINGS AND SECTOR BETS STAY BROAD-BASED

For core exposure, both advisors lean on low-cost, broad-market funds rather than tactical bets. Rathbun holds general market ETFs tracking the Russell 1000 growth and value indexes, the Russell 2000, and the MSCI ACWI ex-US index, alongside actively managed fixed income ETFs such as the T. Rowe Price Total Return ETF (PSDM), where she believes active management adds value.

Ingraham’s core equity holdings include the Vanguard Growth ETF (VUG), the Vanguard Value ETF (VTV), and the Vanguard International Dividend Growth ETF (VIGI), alongside IEMG, with fixed income anchored by the iShares Core US Aggregate Bond ETF (AGG), the iShares 1−5 Year Investment Grade Corporate Bond ETF (IGSB), and the Janus Henderson Securitized Income ETF (JSCP).

Eddie Ghabour, co-founder and chief executive of Key Advisors Wealth Management, is leaning into sectors he expects to benefit from an accelerating economy. “We believe this economy is going to accelerate in the coming months due to the productivity boom from AI and an accommodative monetary policy cycle we are still in,” Ghabour says. He names industrials, citing data-center buildouts; small caps, which he says could gain the most productivity benefit from AI; financials, which he calls “a goldilocks scenario”; and software, where he says companies “have much easier comps over the next 6−12 months and have already lived through a correction.”

On the other side, Ghabour says he is avoiding defensive sectors. “When you have a booming economy, we would stay away from defensive areas like consumer staples − which we would underweight − healthcare, and utilities,” he says.