Moreover, the ETFs’ components are selected based on Zacks Quality, which refers to the amount of non-cash components, or accruals, in each company’s reported earnings – only 10% of firms with the lowest sector-adjusted accruals are eligible for inclusion.
“Research shows an inverse relationship between accruals and stock returns – the lower the non-cash component of earnings, the higher the performance tends to be,” Mitch added.
After accounting for the earnings estimates and quality, the component picks are controlled for risk exposure by diversifying across sectors.
Mike McGlone, Head of US Research for ETF Securities, points out that ZSML and ZLRG’s underlying indices first select stocks with high Zanks earnings ranks and then equally weight sectors and stocks to better manage risk – the indices break down the market into 16 sectors, which are initially weighted at 6.25%. [Multi-Layered, Smart-Beta ETFs Break from Traditional Market-Cap Mold]
“An additional level of risk management is achieved by strict liquidity and capacity screens, equally weighting each sector and equally weighting each stock within each sector,” McGlone added.
Financial advisors who are interested in learning more about the Zacks earnings strategies can listen to the webcast here on demand.