Exchange Traded Concepts, the Oklahoma City-based ETF sponsor
behind the "ETF In A Box" concept, on Thursday plans to launch its
latest ETF-an equities fund that relies on forensic accounting to
pick stocks based on the quality of their earnings.
The Forensic Accounting ETF (NYSEArca:FLAG), as the name
suggests, applies forensic accounting principles to a universe of
500 large-cap stocks in an effort to "red-flag" companies with
accounting or performance issues and exclude them.
The portfolio is a long-only basket of roughly 400 stocks deemed
to have solid earnings quality. The securities are graded on those
earnings, and ranked according to that grade rather than being
ranked by market capitalization.
Forensic accountant John Del Vecchio is behind the Del Vecchio
Earnings Quality Index that was created for the ETF. Del Vecchio is
also the portfolio manager for AdvisorShares' Ranger Equity Bear
ETF (NYSEArca:HDGE), a short-only fund that also relies on forensic
accounting, among other criteria, to select stocks.
Del Vecchio is hoping FLAG will find a niche among investors who
have watched too many companies cook the books to the detriment of
"Every company experiences a bump in the road; there's no
company that's going to have just a clear straight trajectory of
growth," Del Vecchio said in a recent interview.
"But how the company withstands the bump in the road will have a
lot to do with its management, and with its ability to sell its
product," he added. "At the end of the day, a company's earnings
quality is the most crucial metric here."
To be clear, FLAG is not a long-only version of the actively
managed short-only HDGE, which has gathered $192.5 million in its
first two years. But both funds rely on Del Vecchio's
"We seek to generate the alpha of a short-seller without
shorting stocks," Del Vecchio said. "By culling potential losers,
we attempt to capitalize on the fact that most stocks underperform
The companies that are selected from the original pool of 500
large-cap stocks are awarded a grade based on their earnings
quality, and those that get an "A" make up 40 percent of the
Other grade-level stocks such as "B," "C" and "D" each make up
20 percent of the pie. Securities are equally weighted within their
grade levels. Grades are calculated monthly and the index is
reconstituted twice a year.
Companies that have overstated revenue, underestimated expenses,
generated unsustainable sources of cash flow or that are otherwise
viewed as underperforming are excluded from the index.
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