With more than 1,000 products on the market, you’ll find all sorts of exchange traded funds (ETFs) to mimic different investment strategies. One of the newer types is quantitative index based ETFs that promise high-octane returns.
Two primary characteristics of ETFs are that they:
- track the holdings and performance of a defined “index” of securities; and
- enable investors to cost-efficiently purchase such an index as a single basket of securities, which can be bought and sold like a stock.
Typically, indexes are designed to track the average performance of a group of stocks. In order to do so, they are weighted by a couple of different methods, with the most prominent one being the market-weighted method, Scott Martindale of Trading Markets explains.
However, as markets rise, the cap-weighted indexes tend to overweight large companies at the expense of smaller ones. In response, enhanced indexing has curried favor recently. [As Markets Change, New ETFs Come Into Favor.]
“The goal [of enhanced indexing]is to identify a subset of stocks from within a traditional broad-based index that exhibit certain key characteristics, providing the greatest potential for capital appreciation.”
The second level of enhanced indexing, or quantitative indexing, looks at a wider variety of factors that include fundamental, technical and sentiment-oriented characteristics (e.g. insider buying, put/call options activity).