Growth has been an outperforming style this year as the U.S. equity rally extends, but the surge can’t last forever. Alternatively, investors concerned about a potential shift in the investment environment may consider turning to exchange traded funds that are backed by fundamentals and offer an attractive value play.
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. Revenue weighting may also provide a more value-oriented portfolio and historically outperformed in a value-driven market while showing lower drawdowns during growth-driven markets.
According to Morningstar data, RWL includes a 41.0% tilt toward large-cap value and 10.0% to mid-cap value stocks. Furthermore, the ETF is trading at a 17.3 price-to-earnings ratio and a 2.4 price-to-book, compared to the S&P 500’s 20.4 P/E and 2.9 P/B.
Value stocks usually trade at lower prices relative to fundamental measures of value, like earnings and the book value of assets. On the other hand, growth-oriented stocks tend to run at higher valuations since investors expect the rapid growth in those company measures, but more are growing wary of high valuations, especially as the U.S. equities market moves toward the ninth year of an extended bull run.
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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.
Furthermore, the alternative indexing methodology may diminish some of the risks found in traditional beta index funds. 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.
For more information on alternative indexing strategies, visit our smart beta category.