by Aaron Levitt | June 12, 2013 6:00 am
As bread ‘n’ butter indices and sectors have been saturated by exchange-traded fund coverage, issuers have increasingly stretched the limits on what ETFs can handle. The latest trend involves fundamental indexing — applying restrictions or screens to broad market indices to include only the best stocks in hopes of outperforming the market.
Unfortunately, most of these funds have fallen flat, offering little to no advantage over the vanilla index-trackers — and for higher fees to boot.
But one new fund from ALPS might just break that mold.
Considered to be one of the pillars of financial journalism, media outlet Barron’s has partnered with the fund distributor to create a new ETF based on their popular Barron’s 400 index. The index, which offers “growth at a reasonable price” (or GARP) investing, has an impressive history, and could be the right new infusion for investor portfolios.
According to pundits, one of the problems with standard indexing is that along with all the “good” companies, you get the “bad” ones as well, which drags on potentially market-beating returns.
That’s where fundamental indexing — and the new Barron’s 400 ETF (BFOR) — comes in.
Appearing weekly/daily in Barron’s print and online publications, BFOR’s index was launched in 2007 and uses a unique process to select stocks that have growth characteristics and are trading at reasonable prices … similar to what many Barron’s writers do for their weekly and daily columns.
The 400-stock index is built on the back of the Dow Jones U.S. Total Stock Market Index, which itself contains about 6,000 stocks. Firms in this benchmark are then graded and ranked, based on 24 metrics of growth, value, profitability and cash flows. Companies that have a market cap below $3 billion, have a minimum three-month average dollar-trading volume of less than $2 million or are real estate investment trusts are kicked to the curb.
The remaining stocks a given a single numerical score that ultimately determines which stocks are selected to the index. Whatever firms are selected are then equally weighted — with sectors are capped at 20% — to form the Barron’s 400, which is then rebalanced twice a year.
While that seems like a complicated process, it has produced some pretty impressive results. Since its launch, the Barron’s 400 has managed to outperform both the S&P 500 and the Dow Jones Industrial Average. As of the end of May, the fundamental index has managed to produce a five-year annualized total return of 7.7%, topping the S&P 500′s 5.5% performance and the Dow’s 6.6% gain.
Part of the reason for this outperformance could be the “stock picking” of the various screens, though perhaps the biggest player is the Barron’s 400 equal weighting.
BFOR’s feeder index not only includes large-caps like Microsoft (MSFT), but plenty of small- and midcap exposure as well. That produces an interesting mix of companies to choose from, and the various screens employed by Barron’s have tilted the index toward these smaller stocks. In fact, close to 50% of the fund’s holdings are in small-caps like electrical transmission equipment firm AZZ (AZZ) or RFID specialist Zebra Technologies (ZBRA).
Over long periods of time, both small- and midcaps tend to outperform their bigger brothers. So while there’s still plenty of large-cap muscle in BFOR, the hefty exposure to these tinier firms have provided enough “oomph” to help Barron’s index outperform the large-cap, unequally weighted indices.
The five-year history of the Barron’s 400 is certainly impressive, and BFOR could warrant its 0.65% in annual expenses. While that’s more than a standard index fund, it’s much less than the average active mutual fund, which typically underperforms its benchmark — before fees. Trading volumes for the fund already have been swift; if it can continue to put up great numbers, BFOR could find its place in many portfolios alongside broad index funds.
However, it’ll have plenty of competition.
For example, the $4.1 billion Guggenheim S&P 500 Equal Weight ETF (RSP) has managed to match the Barron’s 400 index’s returns during the past five years. Unlike BFOR, RSP doesn’t use any fancy screens and just equal-weights all the stocks in the S&P 500. The lack of a screening process allows Guggenheim to charge just 0.4% for the fund. Investors might not be willing to pay more for an unestablished fund when they can get similar results for cheaper.
Still, the Barron’s 400 ETF is an interesting new option in the fight for market outperformance. If the new fund manages to continue its market-beating streak, I anticipate that Barron’s and ALPS will have a big hit on their hands.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.
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