As the exchange traded funds industry has evolved, issuers have adopted various weighting methodologies for equity-based funds. Investors now have plenty of options to pick from among ETFs that are weighted by fundamental factors, such as earnings or revenue.

The Diamond Hill Valuation-Weighted 500 ETF (NYSEArca: DHVW) takes things a step, or several steps, further by employing intrinsic value capitalization as the cornerstone of how it weighs its holdings. The Diamond Hill Valuation-Weighted 500 ETF tracks the Diamond Hill Valuation-Weighted 500 Index, which is comprised of approximately 500 of the largest U.S.-listed equity securities weighted by intrinsic value capitalization.

DHVW’s underlying index “uses a proprietary, patent-pending valuation methodology developed by Diamond Hill Capital Management, Inc. to evaluate the 700 largest U.S.-listed equity securities by market capitalization. Fundamental company data and consensus earnings per share estimates are used to estimate cash flows and determine terminal value at the end of five years. Cash flows are discounted to estimate intrinsic value and determine the intrinsic value capitalization for each of the 700 companies in the starting universe. A portfolio of the 500 largest companies by intrinsic value capitalization is created, eliminating the bottom 200,” according to Diamond Hill.

Using a trait such as intrinsic value as an ETF’s primary backstop might seem like a recipe for active management, but DHVW is actually a passive fund and a reasonably priced one at that with an annual fee of 0.35%.

“The intrinsic value calculation is designed to look beyond current market price and estimate intrinsic value based on cash flows over the next five years. This forward-looking element is an important distinction to the current price snapshot used by market capitalization-weighted indexes,” according to Diamond Hill. [Inside View of Smart Beta]

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