Exchange traded funds (ETFs) come in all different shapes, sizes and indexing strategies. Weighting by company size is one of the most commonly used methods, but there are other indexing strategies that may be better in specific economic conditions.
Consider revenue-weighting.
Indexing based on revenues, rather than a company’s size, may be an appealing strategy for an economic cycle entering a recovery mode. A revenue-weighted model is better suited at the moment, as it offers more-direct exposure to better-capitalized companies and stronger earnings than a traditional capitalization-weighted index, says Jeff Benjamin for Investment News. [Why Equal Weight ETFs Are Beating the Market.]
Most companies are in really good shape right now because they’ve gone through and chopped expenses as much as possible, and they’re sitting on a ton of cash. As we get into a situation where the economy improves, it could bode well for those companies with better sales. [ETFs And Indexing; Beyond Market-Cap Weighting.]
The ultimate objective in revenue-weighting is to maintain an index with a lower price-to-sales ratio, which shows measurable benefits. Ultimately, a market-cap-weighted index will always be more heavily weighted in companies with the best recent performance, and underweight those companies with the worst recent performance.
There are two main benefits to weighting by revenue:
- Intuitively, weighting by revenue makes sense because bigger revenues usually mean bigger profits and better businesses.
- Market cap doesn’t always reflect a firm’s underlying business value–just look at what happened in the dot-com bubble.
RevenueShares is the only ETF provider that uses this method. You can find details on all six of their ETFs on the ETF Analyzer, as well as sort by performance, expense ratio and more. If you go, you’ll see that most of their ETFs have beaten the S&P 500 in the last three months, including:
- RevenueShares Navellier Overall A-100 ETF (NYSEArca: RWV)
- RevenueShares Small Cap ETF (NYSEArca: RWJ)
Tisha Guerrero contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.