The U.S. bull market rally is continuing on its ninth year, but some are growing concerned over high-flying large-caps taking up bigger weights in traditional beta-index exposure. Alternatively, investors may consider smart beta, large-cap exchange traded funds that try to focus on factors that could limit risks and still provide exposure to upside potential.
The so-called smart beta, enhanced, strategic beta, alternative or factor-based index ETFs all follow a similar theme where the underlying indices eschew conventional market capitalization-weighted methodologies for customized or rules-based allocations, tracking a range of strategies from equally weighting stocks to identifying momentum across different corners of the market, among many others. What ties the theme together is the ability to add exposure to specific factors found in traditionally active managed funds.
There are now hundreds of smart beta or factor-based strategies available, ranging from minor tweaks on existing broad-based indices to more customized options that capture returns from specific styles or asset categories.
For instance, the PowerShares FTSE RAFI US 1000 Portfolio (NYSEArca: PRF), which has been around since December 19, 2005, ranks among the longest running multi-factor, smart-beta ETFs in the U.S. markets. PRF tracks 1,000 U.S. stocks that show the highest fundamental strength based on the RAFI fundamental indexing methodology, which screens for sales, book value, cash flow and dividends.
The Schwab Fundamental U.S. Large Company Index ETF (NYSEArca: FNDX) focuses on retained operating cash flow, adjusted sales, and dividends plus buybacks. While not an overt buyback, dividend or value ETF, FNDX marries those components through large weights to sectors that can be considered value groups (think energy and financial services) as well as allocations to some of the largest share repurchasers and companies that have long histories of increasing dividends.
The First Trust Large Cap Core AlphaDEX Fund (NYSEArca: FEX) also tracks an enhanced index that incorporates growth and value screens. Growth factors including 3-, 6- and 12- month price appreciation, sales to price and one year sales growth, and separately on value factors including book value to price, cash flow to price and return on assets.
The PowerShares S&P 500 High Quality Portfolio (NYSEArca: SPHQ) is one of the elder statesmen of the quality ETF category, having come to market in late 2005. The ETF’s quality tilt comes by way of emphasizing companies’ long-term earnings growth dividend-paying potential. The underlying index focuses on companies with the highest quality as determined by fundamental measures, including return on equity, accruals ratio and financial leverage ratio.
Additionally, the Oppenheimer Large Cap Revenue ETF (NYSEArca: RWL) is a strategy comprised of the same securities as the S&P 500 index, except the fund’s securities are ranked by top line revenue. Components are then rebalanced every quarter to keep the Revenue-Weighted index in line with the companies’ most recently reported revenue levels.
For more information on alternative index-based strategies, visit our Smart Beta Channel.