The vast majority of equity ETFs weight their holdings by
market capitalization. It ensures that investors obtain exposure
to economic activity and value as determined by the market's
collective judgement.
Unfortunately the market's collective judgement includes
plenty of panic and greed-driven volatility. Various studies
suggest that weighting holdings with less subjective measures of
a company's worth such as price/earnings, earnings growth and
dividend yield could deliver less volatility and greater
return.
The concept is perfect for ETFs, and over one hundred have
been launchd to pursue such alternative weighting strategies.
They are called by such names as fundamental, active, dynamic,
and intelligent. In this report we tackle ETFs which weight
holdings based on multiple fundamental finanancial ratios. (See
also our reports on equally weighted and earnings weighted ETFs
and on high-dividend yield ETFs.)
The backdrop to these efforts is the debate about how
efficient capital markets are and what constitutes proof of
inefficiency. Clearly alternative weighting proponents feel they
have found a free lunch. Some researchers agree, some remain
skeptical, and others say any free lunch is likely to be
short-lived and therefore of dubious practical value.
The typical fundamenal/alternative weighting ETF follows the
following steps:
- Identify a list of potential stocks from a cap weighted
benchmark index
- Score each company based on fundamental financial
measures
- Filter out poor scoring companies
- Buy high-scoring firms weighted by fundamental financial
measures
- Identify a list of potential stocks from a cap weighted
benchmark index
- Score each company based on fundamental financial
measures
- Filter out poor scoring companies
- Buy high-scoring firms weighted by fundamental financial
measures
Identify a list of potential stocks from a cap weighted
benchmark index
Score each company based on fundamental financial
measures
Filter out poor scoring companies
Buy high-scoring firms weighted by fundamental financial
measures
Such schemes may be based on mathematical formulas, but
curiously their strategies exploit behavioral psychology. In
First Trust's Alphadex line, for instance, "a value model is
applied to exploit the tendency of investors to extrapolate past
results and a growth model is applied to take advantage of the
tendency for investors to under-react to new information."
These schemes can get quite complicated. The Alphadex value
model uses book value-to-price and cash flow-to-price ratios and
return on assets (
ROA
). The growth model uses five factors: momentum of price
appreciation over three, six and 12 months, one-year sales growth
rate and sales-to-price ratio. Both models are used
simultaneously in a single fund.
With multiple financial ratios stitched together in a hidden
formula, it is impossible to assess how such alternative
weighting schemes might do in various economic situations.
Analysis comes down to faith in the provider, robustness of back
tested results, and the fee hurdle which must be cleared. These
are summarized in the question: is there likely enough excess
performance to justify paying the additional .5% or so in extra
annual fees for these types of ETFs?
In many cases these ETFs have delivered the goods. One such
fund is PowerShares Dynamic Large Cap Portfolio ETF (
PJF
) which targets the top 250 US stocks by market cap. Despite high
annual fees of 0.6%, PJF partly skirted substantial damage in
late 2008. It was a better place to be, for instance, than
Vanguard Mega Cap 300 ETF (
VNQ
), which targets the top 300 US stocks with traditional cap
weighting and charges only .13% in annual fees:
Unfortunately, mere outperformance (or underperformance) in
the short-run is only anecdotal evidence of superiority or
inferiority and is a poor predictor of the future. Very strong
deviation from the benchmark especially is not likely to
linger.
Some ETFs seem to have no chance of outperforming. First Trust
Large Cap Core AlphaDEX ETF (NYSEArca:FEX), with annual fees of
0.7%, essentially goes head-to-head with the S&P 500,
represented well by the SPDR 500 (
SPY
). Unfortunately they correlate so highly it seems doubtful that
FEX can generate sufficient excess performance reliably to pay
for its extra .6% in fees.
Other large company and broad-market fundamental ETFs
include:
- PowerShares FTSE RAFI US 1000 Portfolio ETF
(NYSEArca:PRF), annual fees: 0.6%
- PowerShares Active Mega Cap ETF (NYSEArca:PMA), annual
fees: 0.75%
- PowerShares Active Alpha Multi-Cap ETF (NYSEArca:PQZ),
annual fees: 0.75%
- Various offerings address small and mid-cap asset
classes:
- First Trust Mid Cap Core AlphaDEX ETF (NYSEArca:FNX),
annual fees: 0.7%
- PowerShares Dynamic Small Cap Portfolio ETF (
PJM
), annual fees: 0.6%
- PowerShares Dynamic Mid Cap Portfolio ETF (
PJG
), annual fees: 0.6%
- First Trust Small Cap Core AlphaDEX ETF (NYSEArca:FYX),
annual fees: 0.7%
- Other ETFs slice and dice the market by company size and
growth vs. value characteristics:
- First Trust Large Cap Growth Opportunities AlphaDEX ETF
(NYSEArca:FTC), annual fees: 0.7%
- First Trust Large Cap Value Opportunities AlphaDEX ETF
(NYSEArca:FTA), annual fees: 0.7%
- First Trust Multi Cap Growth AlphaDEX ETF (NYSEArca:FAD),
annual fees: 0.7%
- First Trust Multi Cap Value AlphaDEX ETF (NYSEArca:FAB),
annual fees: 0.7%
- PowerShares Dynamic Large Cap Value ETF (
PWV
), annual fees: 0.6%
- PowerShares Dynamic Mid Cap Growth Portfolio ETF (
PWJ
), annual fees: 0.6%
- PowerShares Dynamic Mid Cap Value Portfolio ETF (
PWP
), annual fees: 0.6%
- PowerShares Dynamic Small Cap Growth ETF (
PWT
), annual fees: 0.6%
- PowerShares Dynamic Small Cap Value ETF (
PWY
), annual fees: 0.6%
- PowerShares FTSE RAFI US 1000 Portfolio ETF (NYSEArca:PRF),
annual fees: 0.6%
- PowerShares Active Mega Cap ETF (NYSEArca:PMA), annual
fees: 0.75%
- PowerShares Active Alpha Multi-Cap ETF (NYSEArca:PQZ),
annual fees: 0.75%
- Various offerings address small and mid-cap asset
classes:
- First Trust Mid Cap Core AlphaDEX ETF (NYSEArca:FNX),
annual fees: 0.7%
- PowerShares Dynamic Small Cap Portfolio ETF (
PJM
), annual fees: 0.6%
- PowerShares Dynamic Mid Cap Portfolio ETF (
PJG
), annual fees: 0.6%
- First Trust Small Cap Core AlphaDEX ETF (NYSEArca:FYX),
annual fees: 0.7%
- Other ETFs slice and dice the market by company size and
growth vs. value characteristics:
- First Trust Large Cap Growth Opportunities AlphaDEX ETF
(NYSEArca:FTC), annual fees: 0.7%
- First Trust Large Cap Value Opportunities AlphaDEX ETF
(NYSEArca:FTA), annual fees: 0.7%
- First Trust Multi Cap Growth AlphaDEX ETF (NYSEArca:FAD),
annual fees: 0.7%
- First Trust Multi Cap Value AlphaDEX ETF (NYSEArca:FAB),
annual fees: 0.7%
- PowerShares Dynamic Large Cap Value ETF (
PWV
), annual fees: 0.6%
- PowerShares Dynamic Mid Cap Growth Portfolio ETF (
PWJ
), annual fees: 0.6%
- PowerShares Dynamic Mid Cap Value Portfolio ETF (
PWP
), annual fees: 0.6%
- PowerShares Dynamic Small Cap Growth ETF (
PWT
), annual fees: 0.6%
- PowerShares Dynamic Small Cap Value ETF (
PWY
), annual fees: 0.6%
PowerShares FTSE RAFI US 1000 Portfolio ETF (NYSEArca:PRF),
annual fees: 0.6%
PowerShares Active Mega Cap ETF (NYSEArca:PMA), annual fees:
0.75%
PowerShares Active Alpha Multi-Cap ETF (NYSEArca:PQZ), annual
fees: 0.75%
Various offerings address small and mid-cap asset
classes:
First Trust Mid Cap Core AlphaDEX ETF (NYSEArca:FNX), annual
fees: 0.7%
PowerShares Dynamic Small Cap Portfolio ETF (
PJM
), annual fees: 0.6%
PowerShares Dynamic Mid Cap Portfolio ETF (
PJG
), annual fees: 0.6%
First Trust Small Cap Core AlphaDEX ETF (NYSEArca:FYX),
annual fees: 0.7%
Other ETFs slice and dice the market by company size and
growth vs. value characteristics:
First Trust Large Cap Growth Opportunities AlphaDEX ETF
(NYSEArca:FTC), annual fees: 0.7%
First Trust Large Cap Value Opportunities AlphaDEX ETF
(NYSEArca:FTA), annual fees: 0.7%
First Trust Multi Cap Growth AlphaDEX ETF (NYSEArca:FAD),
annual fees: 0.7%
First Trust Multi Cap Value AlphaDEX ETF (NYSEArca:FAB),
annual fees: 0.7%
PowerShares Dynamic Large Cap Value ETF (
PWV
), annual fees: 0.6%
PowerShares Dynamic Mid Cap Growth Portfolio ETF (
PWJ
), annual fees: 0.6%
PowerShares Dynamic Mid Cap Value Portfolio ETF (
PWP
), annual fees: 0.6%
PowerShares Dynamic Small Cap Growth ETF (
PWT
), annual fees: 0.6%
PowerShares Dynamic Small Cap Value ETF (
PWY
), annual fees: 0.6%
For sector investors there are numerous offerings:
- First Trust Utilities AlphaDEX ETF (NYSEArca:FXU), annual
fees: 0.7%
- PowerShares Dynamic Banking Portfolio ETF (
PJB
), annual fees: 0.6%
- PowerShares Dynamic Basic Materials Sector Portfolio ETF
(
PYZ
), annual fees: 0.6%
- PowerShares Dynamic Biotechnology & Genome ETF (
PBE
), annual fees: 0.6%
- PowerShares Dynamic Building & Construction Portfolio
ETF (
PKB
), annual fees: 0.6%
- PowerShares Dynamic Consumer Discretionary Sector
Portfolio ETF (
PEZ
), annual fees: 0.6%
- PowerShares Dynamic Consumer Staples Sector Portfolio ETF
(
PSL
), annual fees: 0.6%
- PowerShares Dynamic Energy Exploration & Production
Portfolio ETF (
PXE
), annual fees: 0.6%
- PowerShares Dynamic Energy Sector Portfolio ETF (
PXI
), annual fees: 0.6%
- PowerShares Dynamic Financials Sector Portfolio ETF (
PFI
), annual fees: 0.6%
- PowerShares Dynamic Food & Beverage Portfolio ETF (
PBJ
), annual fees: 0.6%
- PowerShares Dynamic Healthcare Sector Portfolio ETF (
PTH
), annual fees: 0.6%
- PowerShares Dynamic Healthcare Services Portfolio ETF (
PTJ
), annual fees: 0.6%
- PowerShares Dynamic Industrials Sector Portfolio ETF (
PRN
), annual fees: 0.6%
- PowerShares Dynamic Insurance Portfolio ETF (
PIC
), annual fees: 0.6%
- PowerShares Dynamic Leisure & Entertainment Portfolio
ETF (
PEJ
), annual fees: 0.6%
- PowerShares Dynamic Media Portfolio ETF (
PBS
), annual fees: 0.5%
- PowerShares Dynamic Networking Portfolio ETF (
PXQ
), annual fees: 0.6%
- PowerShares Dynamic Oil & Gas Services Portfolio ETF
(
PXJ
), annual fees: 0.6%
- PowerShares Dynamic Pharmaceuticals ETF (
PJP
), annual fees: 0.6%
- PowerShares Dynamic Retail Portfolio ETF (
PMR
), annual fees: 0.6%
- PowerShares Dynamic Semiconductors Portfolio ETF (
PSI
), annual fees: 0.6%
- PowerShares Dynamic Software Portfolio ETF (
PSJ
), annual fees: 0.6%
- PowerShares Dynamic Technology Sector Portfolio ETF (
PTF
), annual fees: 0.6%
- PowerShares Dynamic Telecommunications & Wireless
Portfolio ETF (
PTE
), annual fees: 0.6%
- PowerShares Dynamic Utilities Portfolio ETF (
PUI
), annual fees: 0.6%
- First Trust Technology AlphaDEX ETF (NYSEArca:FXL),
annual fees: 0.7%
- First Trust Consumer Discretionary AlphaDEX ETF (
FXD
), annual fees: 0.7%
- First Trust Consumer Staples AlphaDEX ETF (
FXG
), annual fees: 0.7%
- First Trust Energy AlphaDEX ETF (NYSEArca:FXN), annual
fees: 0.7%
- First Trust Financials AlphaDEX ETF (NYSEArca:FXO),
annual fees: 0.7%
- First Trust Health Care AlphaDEX ETF (NYSEArca:FXH),
annual fees: 0.7%
- First Trust Industrials AlphaDEX ETF (NYSEArca:FXR),
annual fees: 0.7%
- First Trust Materials AlphaDEX ETF (NYSEArca:FXZ), annual
fees: 0.7%
- First Trust Utilities AlphaDEX ETF (NYSEArca:FXU), annual
fees: 0.7%
- PowerShares Dynamic Banking Portfolio ETF (
PJB
), annual fees: 0.6%
- PowerShares Dynamic Basic Materials Sector Portfolio ETF (
PYZ
), annual fees: 0.6%
- PowerShares Dynamic Biotechnology & Genome ETF (
PBE
), annual fees: 0.6%
- PowerShares Dynamic Building & Construction Portfolio
ETF (
PKB
), annual fees: 0.6%
- PowerShares Dynamic Consumer Discretionary Sector Portfolio
ETF (
PEZ
), annual fees: 0.6%
- PowerShares Dynamic Consumer Staples Sector Portfolio ETF (
PSL
), annual fees: 0.6%
- PowerShares Dynamic Energy Exploration & Production
Portfolio ETF (
PXE
), annual fees: 0.6%
- PowerShares Dynamic Energy Sector Portfolio ETF (
PXI
), annual fees: 0.6%
- PowerShares Dynamic Financials Sector Portfolio ETF (
PFI
), annual fees: 0.6%
- PowerShares Dynamic Food & Beverage Portfolio ETF (
PBJ
), annual fees: 0.6%
- PowerShares Dynamic Healthcare Sector Portfolio ETF (
PTH
), annual fees: 0.6%
- PowerShares Dynamic Healthcare Services Portfolio ETF (
PTJ
), annual fees: 0.6%
- PowerShares Dynamic Industrials Sector Portfolio ETF (
PRN
), annual fees: 0.6%
- PowerShares Dynamic Insurance Portfolio ETF (
PIC
), annual fees: 0.6%
- PowerShares Dynamic Leisure & Entertainment Portfolio
ETF (
PEJ
), annual fees: 0.6%
- PowerShares Dynamic Media Portfolio ETF (
PBS
), annual fees: 0.5%
- PowerShares Dynamic Networking Portfolio ETF (
PXQ
), annual fees: 0.6%
- PowerShares Dynamic Oil & Gas Services Portfolio ETF (
PXJ
), annual fees: 0.6%
- PowerShares Dynamic Pharmaceuticals ETF (
PJP
), annual fees: 0.6%
- PowerShares Dynamic Retail Portfolio ETF (
PMR
), annual fees: 0.6%
- PowerShares Dynamic Semiconductors Portfolio ETF (
PSI
), annual fees: 0.6%
- PowerShares Dynamic Software Portfolio ETF (
PSJ
), annual fees: 0.6%
- PowerShares Dynamic Technology Sector Portfolio ETF (
PTF
), annual fees: 0.6%
- PowerShares Dynamic Telecommunications & Wireless
Portfolio ETF (
PTE
), annual fees: 0.6%
- PowerShares Dynamic Utilities Portfolio ETF (
PUI
), annual fees: 0.6%
- First Trust Technology AlphaDEX ETF (NYSEArca:FXL), annual
fees: 0.7%
- First Trust Consumer Discretionary AlphaDEX ETF (
FXD
), annual fees: 0.7%
- First Trust Consumer Staples AlphaDEX ETF (
FXG
), annual fees: 0.7%
- First Trust Energy AlphaDEX ETF (NYSEArca:FXN), annual
fees: 0.7%
- First Trust Financials AlphaDEX ETF (NYSEArca:FXO), annual
fees: 0.7%
- First Trust Health Care AlphaDEX ETF (NYSEArca:FXH), annual
fees: 0.7%
- First Trust Industrials AlphaDEX ETF (NYSEArca:FXR), annual
fees: 0.7%
- First Trust Materials AlphaDEX ETF (NYSEArca:FXZ), annual
fees: 0.7%
First Trust Utilities AlphaDEX ETF (NYSEArca:FXU), annual
fees: 0.7%
PowerShares Dynamic Banking Portfolio ETF (
PJB
), annual fees: 0.6%
PowerShares Dynamic Basic Materials Sector Portfolio ETF (
PYZ
), annual fees: 0.6%
PowerShares Dynamic Biotechnology & Genome ETF (
PBE
), annual fees: 0.6%
PowerShares Dynamic Building & Construction Portfolio ETF
(
PKB
), annual fees: 0.6%
PowerShares Dynamic Consumer Discretionary Sector Portfolio
ETF (
PEZ
), annual fees: 0.6%
PowerShares Dynamic Consumer Staples Sector Portfolio ETF (
PSL
), annual fees: 0.6%
PowerShares Dynamic Energy Exploration & Production
Portfolio ETF (
PXE
), annual fees: 0.6%
PowerShares Dynamic Energy Sector Portfolio ETF (
PXI
), annual fees: 0.6%
PowerShares Dynamic Financials Sector Portfolio ETF (
PFI
), annual fees: 0.6%
PowerShares Dynamic Food & Beverage Portfolio ETF (
PBJ
), annual fees: 0.6%
PowerShares Dynamic Healthcare Sector Portfolio ETF (
PTH
), annual fees: 0.6%
PowerShares Dynamic Healthcare Services Portfolio ETF (
PTJ
), annual fees: 0.6%
PowerShares Dynamic Industrials Sector Portfolio ETF (
PRN
), annual fees: 0.6%
PowerShares Dynamic Insurance Portfolio ETF (
PIC
), annual fees: 0.6%
PowerShares Dynamic Leisure & Entertainment Portfolio ETF
(
PEJ
), annual fees: 0.6%
PowerShares Dynamic Media Portfolio ETF (
PBS
), annual fees: 0.5%
PowerShares Dynamic Networking Portfolio ETF (
PXQ
), annual fees: 0.6%
PowerShares Dynamic Oil & Gas Services Portfolio ETF (
PXJ
), annual fees: 0.6%
PowerShares Dynamic Pharmaceuticals ETF (
PJP
), annual fees: 0.6%
PowerShares Dynamic Retail Portfolio ETF (
PMR
), annual fees: 0.6%
PowerShares Dynamic Semiconductors Portfolio ETF (
PSI
), annual fees: 0.6%
PowerShares Dynamic Software Portfolio ETF (
PSJ
), annual fees: 0.6%
PowerShares Dynamic Technology Sector Portfolio ETF (
PTF
), annual fees: 0.6%
PowerShares Dynamic Telecommunications & Wireless
Portfolio ETF (
PTE
), annual fees: 0.6%
PowerShares Dynamic Utilities Portfolio ETF (
PUI
), annual fees: 0.6%
First Trust Technology AlphaDEX ETF (NYSEArca:FXL), annual
fees: 0.7%
First Trust Consumer Discretionary AlphaDEX ETF (
FXD
), annual fees: 0.7%
First Trust Consumer Staples AlphaDEX ETF (
FXG
), annual fees: 0.7%
First Trust Energy AlphaDEX ETF (NYSEArca:FXN), annual fees:
0.7%
First Trust Financials AlphaDEX ETF (NYSEArca:FXO), annual
fees: 0.7%
First Trust Health Care AlphaDEX ETF (NYSEArca:FXH), annual
fees: 0.7%
First Trust Industrials AlphaDEX ETF (NYSEArca:FXR), annual
fees: 0.7%
First Trust Materials AlphaDEX ETF (NYSEArca:FXZ), annual
fees: 0.7%
A handful of international oriented ETFs allow exposure
abroad:
- PowerShares FTSE RAFI Asia Pacific ex-Japan ETF
(NYSEArca:PAF), annual fees: 0.8%
- PowerShares FTSE RAFI Developed Markets ETF
(NYSEArca:PXF), annual fees: 0.75%
- PowerShares FTSE RAFI Developed Markets ex-US Small-Mid
Portfolio ETF (
PDN
), annual fees: 0.75%
- PowerShares FTSE RAFI Emerging Markets Portfolio ETF (
PXH
), annual fees: 0.85%
- PowerShares FTSE RAFI Europe ETF (NYSEArca:PEF), annual
fees: 0.75%
- PowerShares FTSE RAFI Japan ETF (NYSEArca:PJO), annual
fees: 0.75%
- PowerShares FTSE RAFI Asia Pacific ex-Japan ETF
(NYSEArca:PAF), annual fees: 0.8%
- PowerShares FTSE RAFI Developed Markets ETF (NYSEArca:PXF),
annual fees: 0.75%
- PowerShares FTSE RAFI Developed Markets ex-US Small-Mid
Portfolio ETF (
PDN
), annual fees: 0.75%
- PowerShares FTSE RAFI Emerging Markets Portfolio ETF (
PXH
), annual fees: 0.85%
- PowerShares FTSE RAFI Europe ETF (NYSEArca:PEF), annual
fees: 0.75%
- PowerShares FTSE RAFI Japan ETF (NYSEArca:PJO), annual
fees: 0.75%
PowerShares FTSE RAFI Asia Pacific ex-Japan ETF
(NYSEArca:PAF), annual fees: 0.8%
PowerShares FTSE RAFI Developed Markets ETF (NYSEArca:PXF),
annual fees: 0.75%
PowerShares FTSE RAFI Developed Markets ex-US Small-Mid
Portfolio ETF (
PDN
), annual fees: 0.75%
PowerShares FTSE RAFI Emerging Markets Portfolio ETF (
PXH
), annual fees: 0.85%
PowerShares FTSE RAFI Europe ETF (NYSEArca:PEF), annual fees:
0.75%
PowerShares FTSE RAFI Japan ETF (NYSEArca:PJO), annual fees:
0.75%
Finally there are various hard-to-classify ETFs:
- PowerShares Active AlphaQ ETF (NYSEArca:PQY), annual
fees: 0.75%
- PowerShares Dynamic Developed International Opportunities
Portfolio ETF (
PFA
), annual fees: 0.75%
- PowerShares Dynamic MagniQuant Portfolio ETF (
PIQ
), annual fees: 0.6%
- PowerShares Dynamic Market Portfolio ETF (
PWC
), annual fees: 0.6%
- PowerShares Dynamic OTC Portfolio ETF (
PWO
), annual fees: 0.6%
- PowerShares Active AlphaQ ETF (NYSEArca:PQY), annual fees:
0.75%
- PowerShares Dynamic Developed International Opportunities
Portfolio ETF (
PFA
), annual fees: 0.75%
- PowerShares Dynamic MagniQuant Portfolio ETF (
PIQ
), annual fees: 0.6%
- PowerShares Dynamic Market Portfolio ETF (
PWC
), annual fees: 0.6%
- PowerShares Dynamic OTC Portfolio ETF (
PWO
), annual fees: 0.6%
PowerShares Active AlphaQ ETF (NYSEArca:PQY), annual fees:
0.75%
PowerShares Dynamic Developed International Opportunities
Portfolio ETF (
PFA
), annual fees: 0.75%
PowerShares Dynamic MagniQuant Portfolio ETF (
PIQ
), annual fees: 0.6%
PowerShares Dynamic Market Portfolio ETF (
PWC
), annual fees: 0.6%
PowerShares Dynamic OTC Portfolio ETF (
PWO
), annual fees: 0.6%
Co-founder of indexfunds.com, author of two books on
investing, and founder of ETFzone.com, Will has been writing on
indexing issues for 8 years. He holds an MBA from the
University of Texas at Austin.
Co-founder of indexfunds.com, author of two books on
investing, and founder of ETFzone.com, Will has been writing on
indexing issues for 8 years. He holds an MBA from the University
of Texas at Austin.