Wow, what a big move in the world of ETFs over the past few years! The ETF innovation created very easy ways to invest in groups of securities at prices below those of mutual funds.
Some ETFs allow managers to get very creative when it comes to building alternative portfolio strategies. We don’t have to get stuck to the same boring asset classes like we did in the old days. Now we get to play with very targeted strategies.
These alternative ETFs may seem exotic at first, and some of them are. You want to stay away from things you don’t understand, like poltergeists and various strange collections of securities. However, the top three performing alternative ETFs so far this year consist of really intelligently designed baskets of securities.
This doesn’t mean that their outperformance will continue, but it is worth examining these three selections to see if they fit your risk profile. If not, or if they seem too exotic, then stay away.
Top Alternative ETFs: ALPS Equal Sector Weight ETF (EQL)
Expenses: 0.3%, or $30 per $10,000 invested
Coming in third place for alternative ETFs YTD, at 4.5%, is ALPS Equal Sector Weight ETF (EQL).
The theory with this ETF is that one can smooth out volatility and more properly balance a portfolio by investing equally in each of the nine major sectors in the market — healthcare, energy, materials, utilities, consumer staples, financials, industrials, tech and consumer discretionary.
Because it is impossible to jump from one sector to another in terms of overweighting one and underweight another, and capture all the right moves at the right time, EQL deploys about 11.1% of its assets into each sector. This way, you always participate in those sectors moving higher, and reduce the impact of a crash in any given sector.
It removes overweight exposure to many momentum stocks that occur in cap-weighted ETFs.
The net expense ratio is 0.3%. That’s paid for by the 2.1% yield.
Top Alternative ETFs: PowerShares S&P 500 Quality Portfolio (SPHQ)
In second place, with a year-to-date return of 6%, is the PowerShares S&P 500 Quality Portfolio (SPHQ).
As alternative ETFs go, the SPHQ uses a witches’ brew of considerations. It screens according to a “quality score” which measures several factors. It looks at profitability as measured by return on equity. It looks at earnings, which is measured by the less-known “accruals ratio.” That essentially factors cash flow into earnings estimates. It uses a financial risk angle, which measures the degree to which debt is used to finance operations.
SPHQ managers believe that in times of higher market volatility and widening credit spreads, stocks with this higher “quality score” perform better than the market.
This fund takes the S&P 500, then grabs about 100 stocks with the highest quality score, and then weights them by multiplying market cap by that score.
The net expense ratio is a mere 0.29%. Since the yield is about 2%, the expense ratio is effectively covered by the ETF’s dividends.
Top Alternative ETFs: PowerShares S&P 500 Low Volatility ETF (SPLV)
The top performer so far this year is the PowerShares S&P 500 Low Volatility ETF (SPLV), which is up 6.45%. This may appeal most to investors who do not enjoy momentum stocks, and don’t want huge moves in their portfolio from one day to the next.
This ETF starts with the S&P 500, but then pares it down to the 100 stocks that had the lowest volatility over the trailing 12 months.
What is volatility and how is it measured by the fund? This alternative ETF keeps it simple: it just refers to volatility as “magnitude of price movements.”
According to fund literature, this approach of correlating volatility and performance appears to work, by capturing 72% of the S&P 500’s increasing moves but only 42% of the declines.
As of this writing, Lawrence Meyers had no position in any security mentioned.