Fundamental weighting methodologies offer investors alternatives to the traditional market capitalization-weighted indices that are so prevalent among broad market and sector ETFs. Not only that, but fundamental weighting is growing in popularity and use.
The ETF industry is crafting new products based on alternative or “enhanced” indexing methodologies, constructing indices that screen and weight component stocks based on a number of factors, such as adjusted sales, cash flow, dividends and buybacks. [Jaffe Weighs in on Schwab Fundamental ETFs]
The increasing popularity of fundamentally-weighted ETFs is becoming more apparent. For example, Charles Schwab (NYSE: SCHW) will introduce six such products on Thursday. Earlier this year, Invesco’s (NYSE: IVZ) PowerShares, the fourth-largest U.S. ETF issuer, said its line of RAFI Fundamental” ETFs, which are based on the Research Affiliates Fundamental Index methdology, reached $5 billion in assets under management. [PowerShares Fundamental ETFs Hit $5 Billion]
Among those funds is the $346.4 million PowerShares FTSE RAFI Emerging Markets Portfolio (NYSEArca: PXH). As a diversified emerging markets ETF, PXH competes directly with cap-weighted funds such as the Vanguard FTSE Emerging Markets ETF (NYSEArca: VWO), but as a fundamentally-weighted fund, PXH goes about its business in noticeably different fashion.
With emerging markets starting to show some signs of life, investors may want to consider fundamental weighting as an alternative or complement to existing developing world positions. PXH merits consideration because its underlying index, the FTSE RAFI Emerging Markets Index, has outpaced the MSCI Emerging Markets Index since 2007, according to PowerShares data.
The index evaluates potential holdings based on book value, cash flow, sales and dividends. The result is a 323-stock lineup that is 40% allocated to China and Brazil. A rebound in Chinese stocks has boosted PXH in the past month, but emerging markets investors are still waiting on Brazil to contribute something toward BRIC/emerging markets upside. [BRIC ETF on the Cusp of Breaking Out]
PXH also features a 13.2% weight to Russia, one of the higher allocations to that country among diversified emerging markets ETFs. Significant Russia exposure translates to an almost 24% weight to the energy sector, but Russia has been showing some promise as a dividend destination as the government there pushes its highly profitable companies to increase shareholder payouts.
Importantly, PXH’s fundamental weighting helps investors avoid heavy exposure to stocks that are richly valued. Although the universal view of emerging markets equities at the moment is these stocks are cheap, PXH’s P/E ratio of nine and price-to-book ratio of 0.61 prove the fund is far from frothy when it comes to valuation.
PowerShares FTSE RAFI Emerging Markets Portfolio
ETF Trends editorial team contributed to this post.