At the end of summer, there was nearly $1.5 trillion in assets under management across the U.S. universe of exchange-traded products, including ETFs and ETNs. And while traditional market capitalization weighted funds still rule the roost, ETFs that use alternative weighting strategies deserve attention.
Through mid-2013, non-market cap weighted funds captured 42% of equity ETP flows YTD, more than two times their share of equity assets compared to 2012, according to BlackRock. Key drivers to this trend are dividend income and minimum volatility funds.
It should be noted the universe of non-market cap weighted ETFs includes equal weight funds, low and high volatility products along with fundamentally weighted products that use one or multiple factors for screening and weighting securities. To be sure, investors, professional and retail, have already displayed plenty of adulation for equal weight ETFs.
For example, the Guggenheim S&P 500 Equal Weight ETF (RSP) has outperformed the SPDR S&P 500 (SPY) and related S&P 500 tracking funds by significant margins for some time. Over the past 10 years, RSP has delivered a 9.74% return compared to 7.47% for SPY.
Then there are the examples of equal weight technology sectors that have outperformed cap weighted peers that featured outsized exposure to Apple. Over the past year, Apple is down over 27%, so it might be a pleasant surprise that the cap-weighted PowerShares QQQ (QQQ) is up 16.67%. However, the real pleasant surprise is how the First Trust NASDAQ-100 Equal Weighted Index (QQEW) is up nearly 31% over that same time. This highlights the advantages of devoting less concentration to stock market giants, especially when they falter.
Fundamental Factors
Various ETF issuers feature fundamentally weighted funds that use one or more factors for selecting and weighting stocks.
For example, the RevenueShares ETFs own the same stocks within the S&P 500, S&P MidCap 400 and S&P SmallCap 600, but weight holdings according to top line revenue. "We believe that by applying the revenue weighted methodology to the S&P indexes, investors will lower their exposure from overvalued companies that are inflated by the market," states the company's website.
Other providers, like InvescoPowerShares, take a multi-factor approach, weighting stocks by book value, cash flow, dividends and sales.
Importantly, advisors should note that each issuer applies different fundamental methodologies to their respective ETF menus. Some fundamental ETFs have shown a propensity for outperforming their cap weighted rivals.
Case Study
InvescoPowerShares has one of the largest stables of fundamentally weighted ETFs, and the underlying indexes are managed by FTSE and Research Affiliates (RAFI).
"Unlike traditional benchmark indexes, the FTSE RAFI Index series uses a weighting structure that embodies four fundamental measures of size: five-year averages of sales, cash flow and dividends plus current book value," according to a PowerShares white paper.
