Editor's note: This is Part 2 or Rebalancing Your ETF Portfolio, by Paul Weisbruch of Street One Financial. Here is Part 1.
RevenueShares Large Cap
is based on the
iShares S&P 500 Index
Rydex S&P Equal Weight
The difference is in the weighting methodology, in which the index ranks the S&P 500 components by top-line revenue. This ETF employs a once-per-year rebalancing in December, in which those stocks whose market cap has surged far ahead of revenue growth are trimmed back, and more shares are purchased of those stocks in the index whose price to revenues are trading above the price to shares outstanding.
Similar to the RSP quarterly rebalance, employing some regular rebalance in your investment methodology seems to have benefits in terms of helping you as the investor takes profits in a systematic manner, as well as allocating additional monies to those stocks that may be languishing in your portfolio. As said earlier, market cap doesn't rebalance; it simply follows the peaks and valleys of the market, tracking the benchmarks.
At times, the general market will be overbought and at times oversold, so a straight market-cap index cannot take advantage of these situations and add outperformance because of the lack of a systematic rebalance. The trailing one-year returns of these four S&P 500-based ETFs demonstrate value was added in terms of benchmark outperformance in both RSP and RWL (up 76.07% and 60.06% respectively) vs. the benchmark-driven SPY and IVV up 49.78% and 49.64%, respectively. Net of expenses, as RWL charges 49 basis points as compared with SPY and IVV's 9 basis points, RWL has demonstrated alpha over the past trailing one-year period and since inception in February 2008.
First Trust offers its own twist on the S&P 500, available through
First Trust Large Cap Core AlphaDEX
. According to the First Trust Web site, the universe of stocks selected for FEX is the S&P 500, and through a proprietary screening of growth factors such as three-, six- and 12-month month price appreciation, sales-to-price and one-year sales growth, as well as on value factors such as book-value-to price, cash-flow-to price and return on assets. The S&P 500 stocks are then assigned a score according to these factors, with those with the highest scores fill out FEX, 75% of the S&P 500 are included and the lowest-scoring 25% of the index are discarded and not part of FEX.
Stocks that are selected for inclusion in FEX are divided in quintiles, and the top-ranked quintiles are weighted higher within the ETF. Within each quintile, the stocks are equally weighted. How does FEX rebalance? FEX rebalances quarterly and is also reconstituted quarterly, so it is certainly possible for a member of the S&P 500 that isn't currently included in FEX during the present quarter due to low scoring according to the First Trust screening to appear in FEX in a future quarter due to some improvement in its scoring, and presumably an improvement in its underlying fundamentals.
Like RSP and RWL, FEX costs more than the benchmark ETFs IVV and SPY at 70 basis points, but it has demonstrated outperformance to the benchmark in the trailing one-year period (up 64.56% with SPY and IVV up 49.78% and 49.64% respectively.) Its performance can be seen here
Rebalancing can be achieved through overweighting growth or value, making specific bets on certain sectors within an index to outperform, and overweighting that particular sector while underweighting others, or employing the use of ETFs that have a scheduled rebalance mechanism inherent in their methodologies. A blend of various strategies within one portfolio such as the use of market-cap-weighted ETFs like SPY or IVV in conjunction with equal weighting (RSP), revenue weighting (RWL) and fundamental weighting (FEX), can help put investors over the top of their benchmarks without needing to consciously make growth/value bets nor precisely time which industry sectors will be the winners or losers.
If the net outperformance of alpha-driven ETFs, such as RSP, RWL and FEX, justifies their higher expense ratios, then their effect to the investor's bottom line results can be just as effective and likely much more consistent than having to "call" the market year in and year out.
Paul Weisbruch is the VP of ETF/Index Sales/Trading at Street One Financial, graduating from the University of Pittsburgh, with an MBA from Villanova University. Before Street One, Paul was Director of Institutional ETF Sales at RevenueShares ETFs from December 2007 until November of 2009. Before RevenueShares, Paul was employed by Susquehanna International Group from 2000 until 2007, serving in roles including ETF Floor Specialist on the PHLX, ETF/Derivatives Intelligence, and Algorithmic Trading. Paul has been quoted in ETF industry publications including Morningstar, Traders Magazine, and Index Universe. He holds his Series 4, 6, 7, 55, 63, and 65 licenses.