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Fundamental Indexing Gets Top Marks

Kevin Baker

Unlike typical indices, which weight constituent stocks according to their market capitalization, fundamental indices weight their holdings according to criteria such as the size of their dividends.

TheStreet.com Ratings initiated coverage of 41 exchange-traded funds and four closed-end funds that accrued a sufficient track record one year's worth of risk and performance data by the end of November.

Sixteen of the ETFs that began trading in October 2006 received our top rating of excellent, with five being awarded the top rating of A-plus. Of these, four are members of the WisdomTree family of fundamentally weighted ETFs. All four track international market sectors, including communications, utilities, oil and non-cyclical consumer stocks.

Jeremy Schwartz, deputy director of research at WisdomTree, says the funds hold a "unique slice of the market" for several reasons. First, they are the only pure play for international sectors among ETFs since they hold no U.S. stock exposure.

Second, stocks are selected for the underlying indices with a rules-based methodology without human interaction or prejudice.

But the most important difference between these ETFs and the other exchange-traded funds we rate is the way they weight stocks. Instead of giving the most weight to the stocks with the biggest market cap, WisdomTree ranks them by the total dollar value of dividends paid over the prior year. Dividends actually paid are shielded from potential accounting manipulation. Core earnings are substituted when measuring non-dividend-paying companies.

Schwartz notes that the average dividend yield for the universe of 2,500 international stocks eligible for inclusion in their indices is 3.8%. This compares favorably with the 2.0% dividend yield of the S&P 500 Index dominated by U.S. stocks.

The portfolio of the A-plus-rated WisdomTree International Communications Sector Fund(DGG Quote) scored a gross dividend yield of 4.26% as of Dec. 24.

The largest holdings had a great year, with Vodafone(VOD Quote) up 38.60%, Telefonica (TEF Quote) up 44.82% and China Mobile (CHL Quote) up 126.10%, among others.

The A-plus-rated WisdomTree International Utilities Sector Fund (DPN Quote) has compiled a total return since inception on Oct. 13, 2006, through Nov. 30, 2007, of 43.05%. Schwartz says the fund was well positioned to benefit from the global infrastructure boom and the low-interest-rate environment.

In third place, the A-plus-rated WisdomTree International Consumer Non-Cyclical Sector Fund (DPN Quote) captured one-year returns of 22.99% in Nestle(NSRGY Quote), 45.17% in British American Tobacco (BTI Quote) and 26.86% in Unilever (UN Quote), all of which were among the funds six largest holdings.

The fourth-place, A-plus-rated WisdomTree ETF focuses on the International Energy Sector with top holdings of Total(TOT Quote), BP(BP Quote) and CNOOC(CEO Quote). As part of a diversified portfolio, some exposure to the energy sector is a must-have while oil again flirts with $100 a barrel.

In total, TheStreet.com Ratings assigned buy ratings to 23, hold ratings to nine and sell ratings to the remaining nine exchange-traded funds.

TheStreet.com Ratings also initiated coverage on four closed-end funds. None of them fared well over the last year and all are starting off with a sell range.

The (ETY Quote)Eaton Vance Tax Mgd Div Eqty Inc (ETY) earned an initial rating of E, losing 12.26%.

Also rated E were the (IRR Quote)ING Risk Managed Nat Resources Fund (IRR), down 7.61%, and the (FOF Quote)Cohen & Steers Closed-End Opp Fd (FOF), off 13.09%.

The (DHG Quote)DWS Dreman Value Income Edge Fund (DHG) sank 26.86% in the 12 months ending Nov. 30, locking in the lowest possible rating of E-minus.

Research Methodology

TheStreet.com Ratings condenses the available fund performance and risk data into a single composite opinion of each fund's risk-adjusted performance. This allows the unbiased identification of those funds that have historically done well and those that have underperformed the market.

While there is no guarantee of future performance, these Investment Ratings provide a solid framework for making informed, timely investment decisions.

All the funds listed below have reached their one-year anniversary.

Funds rated A or B are considered buy-rated on the basis of a track record of higher-than-average risk-adjusted performance. Funds at the C level are rated hold, while underperformers at the D and E levels our model ranks as "sell."

For a more detailed explanation of the meaning of each level of our rating, click here.