Fundamental ETFs - Proprietary Methodologies

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Weighting ETF holdings by market capitalization reflects the market's collective judgment of relative worth of securities. There is no assurance, however, that this collective judgment is wise.

Some researchers claim that weighting by market capitalization/valuation fares poorly in returns compared to other weighting methods. These include weighting holdings by fundamental financial measures such as price/earnings, earnings growth and dividend yield.

Over one hundred fundamental ETFs cover every conceivable asset class, and most have proprietary weighting formulas based on multiple financial ratios. These are often referred to as active, semi-active, or dynamic. (See also our reports on transparent fundamental ETFs and high dividend yield ETFs.) In many cases Fundamental ETFs have delivered the goods. Here a smattering of large-cap fundamental ETF returns are shown against SPY, an S&P 500 ETF:

The typical fundamental/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 remaining 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 remaining 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 remaining high-scoring firms weighted by fundamental financial measures
  • Such schemes are based on various mathematical formulas with an eye to exploiting 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." The Alphadex value model uses book value-to-price, cash flow-to-price ratios and return on assets. The growth model uses momentum of price appreciation over three, six and 12 months, one-year sales growth rate and sales-to-price ratio. Both models can be used simultaneously in a single fund.

    Fundamental ETFs are fertile ground for theoretical discussion. At first blush they might seem to imply that there is a free lunch, something that most economists should not in theory happen over time. But they may not be a direct broadside against efficient market theory. Long periods of outperformance does not ensure perpetual outperformance. Historical stock analysis is full of examples of successful strategies which bomb the minute they are declared long-term winners (the supposed value premium being the most famous example). And clearly the more assets they attract, the more they will crowd out their own strategies and help to create an efficient market.

    The fees of some fundamental ETFs make their task harder. Fundamental ETFs must outperform cap-weighted ETFs by 0.5% or so per year just to recoup their higher fees before they begin to benefit investors. For instance, First Trust Large Cap Core AlphaDEX ETF (NYSEArca:FEX), with annual fees of 0.7%, essentially goes head-to-head with dirt-cheap S&P 500 ETFs at 0.1% 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%

    • 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%
  • 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 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 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%
  • 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%
    • 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 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 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%
  • 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.



    The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



    This article appears in: Investing , ETFs


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