In an attempt to make up for the potential risks of a traditional market capitalization weighting methodology, a smart beta exchange traded fund could help investors to enhance returns and diminish risks ahead.
For example, 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 indices in line with the companies’ most recently reported revenue levels.
Revenue weighting could provide diversified exposure to the market, is not influenced by stock price, reflects a truer indication of a company’s value and offers stable sector exposure. Moreover, revenue weighting may provide a more value-oriented portfolio and historically outperformed in a value-driven market while showing lower drawdowns during growth-driven markets.
By rebalancing toward companies with persistent sales, revenue weighting helps keep a portfolio from overstaying during an overheating market. The result could be a portfolio with better risk-adjusted returns over the long haul.
“We think it is incredibly important to look beyond market capitalization and focus on fundamental metrics such as revenue when building an efficient portfolio,” according to an OppenheimerFunds research note. “Our revenue-weighting methodology can help investors look through the noise of short-term price movements and focus on the long-term fundamentals that matter. Because of this we continue to believe that RWL will provide an opportunity to outperform the capitalization-weighted S&P 500 over the long term.”
Traditional cap-weighted indices, like the S&P 500, are overweight the largest or best performing companies, which leaves less upside potential as the indices are more top heavy on established firms with less room to run. On the other hand, an alternative indexing style, such as a revenue-weighted index methodology, could allow investors to focus on companies continuing to grow.
Moreover, by highlighting fundamental factors like revenue, investors are better able to weather any short-term storms, especially with the market focusing on many of our new president’s pro-growth promises that have yet to come to fruition, other political risks and the Federal Reserve’s recently anticipated increases in rates, which may all further add to short-term risks.