Over the past few years, investors have been searching for investment tools that are “outside the box” to boost returns and add diversification, which has enabled quantitative exchange traded funds (ETFs) to grow at an exponential rate.
In and of itself, the vast majority of ETF assets are still held in traditional beta funds which track well-known benchmarks like the S&P 500, the Russell 2000 or the MSCI Emerging Markets Index. In fact, the SPDR S&P 500 (SPY), the iShares Russell 2000 Index (IYW) and the iShares MSCI Emerging Markets (EEM) continue to remain the most actively traded ETFs and make up a significant percentage of total assets that are invested in ETFs.
However, some ETF providers, like PowerShares, First Trust and Claymore have taken their offerings a step further by utilizing fundamental analysis and other quantitative methodologies to generate excess returns by identifying securities which are set to outperform the broader markets and experience above-average capital appreciation.
One such ETF is the PowerShares Dynamic Large Cap Value Portfolio (PWV), which is designed to evaluate large-cap stocks and seeks to replicate the Dynamic Large Cap Value Intellidex Index, which is designed to select companies poised to outperform broad market benchmarks while maintaining consistent stylistically accurate exposure. PWV boats Verizon Communications (VZ) and Coca-Cola Company (KO) as its top holdings. Over the past three years, PWV has outperformed its competitor, the iShares Russell 1000 Value Index (IWD), which is a beta fund that tracks the Russell 1000 Value Index, by nearly 10 percent.
Another notable mention is the Claymore/Zacks Mid-Cap Core ETF (CZA), which utilizes quantitative methodologies to identify a group of roughly 100 securities that have the potential to outperform the Russell Midcap Index or the S&P 500 MidCap 400 Index. Over the past year, CZA has outperformed both the SPDR S&P MidCap 400 (EDY) and the iShares Russell Midcap Index Fund (IWR) by nearly 5% and 6%, respectively.
A third ETF that utilizes fundamental analysis is the First Trust Health Care AlphaDEX (FXH). FXH is linked to the StrataQuant Health Care Index that determines holdings by rankings on growth factors such as sales to price ratios and 12-month price appreciation as well as value factors such as cash flow to price, return on assets and book value to price. Furthermore, the stocks that are selected in the Index are further split into quintiles based on their ranking, with the top ranked quintile receiving a larger weight within the index. FXH, which has a heavier concentration on mid-cap growth orientated health care securities than either the iShares Dow Jones US Healthcare (IYH) or the Healthcare Select Sector SPDR (XLV) and has outperformed both IYH and XLV over the past year by nearly 12% and 13%, respectively.
Although these three ETFs which utilize quantitative methodologies to choose their holdings appear to be outperforming their respective broader markets, it is equally important to consider the risks that they carry.
A good way to protect against these risks is the use of an exit strategy which identifies specific price points at which downward price pressure is likely to exist. Such a strategy can be found at www.SmartStops.net.
Disclosure: No Positions