Investors considering the smaller segment of the U.S. equities market may look to a revenue-focused exchange traded fund strategy. The value tilt may help this small-cap ETF outperform as the markets normalize.
The Oppenheimer Small Cap Revenue ETF (NYSEArca: RWJ) allows investors to gain exposure to the same securities as the S&P 600 Index but also ranks holdings by top line revenue, instead of market capitalization.
“Our transparent investment process re-weights the S&P 600 by each company’s revenue, producing a portfolio which we think is a better representation of companies’ economic contribution to the index,” according to an OppenheimerFunds note. “By ranking through revenue instead of market capitalization, we remove the traditional index’s bias towards overvalued stocks while maintaining the transparency and broad diversification that has historically attracted investors to index strategies.”
Traditional market-capitalization weighting methodologies would normally be more top heavy, overweighting companies that have outperformed. 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. The revenue-weighting methodology may also help investors focus on more undervalued companies with attractive fundamentals.
Furthermore, RWJ helps investors gain exposure to two factors that have traditionally outperformed markets in the long haul. Historical data and academic studies have found that small size and value factors have outperformed over the long-term, with small-caps outpacing large-caps and value styles outstripping growth.
RWJ’s portfolio includes a 42.2% weight in small-caps and 57.2% in micro-caps. Additionally, the smart beta ETF has a 46% tilt toward the value style, according to Morningstar data.
“While RWJ is classified as a ‘core’ by most metrics, it does skew more into the Value section of the market, and underperformed in Q1,” according to OppenheimerFunds. “As markets normalize we would expect this trend to reverse, and the Fund’s outperformance to resume.”
Moreover, if the U.S. dollar begins to appreciate against foreign currencies, which may occur as the Federal Reserve embarks on interest rate hikes and the U.S. economy continues to improve, smaller companies that focus on the growing domestic economy may outperform their larger counterparts, which may see overseas profits negatively affected by a stronger greenback.
For more information on alternative indexing strategies, visit our smart beta category.