Active ETF Requires Weight Watching

The exchange-traded fund market seems to be moving closer to actively managed ETFs, and the relatively new First Trust Deutsche Bank Value Index Fund(FDV) stands out as the most active.

First Trust Portfolios rebalances the fund's 40 constituents monthly. The strategy is to screen the largest 251 companies in the S&P 500 (excluding the financial sector) for the 40 names that have the lowest "economic" price-to-earnings ratio.

The index the fund mimics is called the Cash Return on Capital Invested (CROCI). The concept isn't easy to explain or understand. The idea is that typical calculation of P/E ratios can be distorted because of the way companies report earnings. The fund's prospectus says that CROCI is an application of the residual-income valuation model. A simpler way to think of it is the net earnings above and beyond the cost of capital.

This is a valuation measure and a large-cap value index. Anyone interested in buying the fund needs to view the fund and temper his expectations toward the value part of the market.

The holdings, which are available on the First Trust Web site, are a mix of stocks where the E, or earnings, is growing faster than the P, or price -- think energy and commodity stocks -- and stocks that are down and out -- think Dell(DELL) and Bristol-Myers Squibb(BMY).

For now, the fund is very heavy in energy, at 22%, compared to just 10.6% in the S&P 500 and 9.2% for the iShares S&P 500 Value Index Fund(IVE). This is worth considering, as presumably First Trust Deutsche Bank Value Index Fund (FDV) is picking its holdings from the iShares S&P 500 Value Index Fund (IVE) pool.

Energy is a great thing, but having too much of a great thing runs the risk of making that great thing a negative, as was the case with tech-heavy portfolios six years ago. I'm as big of an energy bull as most folks, but to have 25% in energy could prove a mistake if the sector were to somehow crash as tech did.