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TheStreet Open House

Fundamental Funds Topped the S&P 500

Stocks in this article: RWL RWJ WMT CVX F PRF DTD CSCO INTC GOOG AAPL

NEW YORK ( TheStreet ) -- The RevenueShares family of ETFs has been on a roll.

Top performers include RevenueShares Large Cap (RWL). During the past five years, the fund returned 9.2% annually, compared to 7.8% for the S&P 500, according to Morningstar. RevenueShares Small Cap (RWJ) returned 13.6% annually, compared to 8.3% for the Russell 2000 small-cap index.

The ETF company has achieved those stellar results by relying on a simple methodology that focuses on revenue. To assemble the large-cap portfolio, RevenueShares starts with the 500 stocks of the S&P 500. Then the company weights the stocks according to their sales. If a company accounts for 2% of the revenue in the S&P 500, then the stock will have 2% of the assets in the ETF.

In contrast, the S&P 500 and most other standard benchmarks weight holdings according to the market values of the stocks. For RevenueShares Large Cap, the biggest holding is Wal-Mart (WMT), which accounts for 4.2% of assets. The giant retailer only accounts for 0.85% of the assets in the S&P 500.

The RevenueShares ETFs are among the most successful funds that follow fundamental approaches. Those weight stocks according to fundamental measures such as revenue, dividends or earnings. Introduced by Research Affiliates in 2005, fundamental strategies now account for $100 billion in assets invested in institutional and retail funds. Successful fundamental ETFs include PowerShares FTSE RAFI 1000 (PRF) and WisdomTree Total Dividend (DTD).

Proponents say fundamental funds can perform so well because they overcome the flaws of market-cap-weighted benchmarks. To appreciate why, consider how the weighting of the S&P 500 shifted during the late 1990s bull market.

At the time, prices of big technology stocks were soaring. As that happened, companies including Cisco Systems (CSCO) and Intel (INTC) came to account for an increasing percentage of assets in the index. When the Internet bubble burst in 2000, the S&P 500 fell hard as technology stocks sank.

Fundamental benchmarks avoid such steep collapses because they don't overweight the hottest stocks. Since measures such as revenue are fairly steady, the stock allocations of fundamental benchmarks tend to avoid sudden shifts.

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