As exchange-traded funds are sliced into increasingly smaller segments, industries and regions, Sean O'Hara and his team have taken a novel approach. As president of RevenueShares Investor Services, O'Hara has helped lead the way in designing ETFs with a new spin. The firm has three ETFs on the market: the RevenueShares Mid Cap Fund ( RWK), the RevenueShares Large Cap Fund ( RWL) and the RevenueShares Small Cap Fund ( RWJ). They track the S&P 400, S&P 500 and S&P 600 indexes, yet they are weighted based on annual revenue rather than market capitalization. The funds, which rebalance yearly, are rooted in the idea that revenue is a metric less prone to manipulation. "We think we can combine traditional market-cap-weighted index funds with a revenue-weighted strategy to extract excess returns," said O'Hara. "We use revenue because it has proven to generate the highest returns among the factors that we considered for rebalancing." The slumping stock market has detracted from the funds' ingenuity. Since their launch March 7, RWK, RWL and RWJ have declined 37.5%, 32.2% and 32.4%, respectively, compared with drops of 32.1%, 27.7% and 26.9% for their benchmarks. The weighting of the funds may lead to underperformance in momentum-dominated markets or ones in which one or two sectors are driving gains. O'Hara said his ETFs ought to come out ahead over longer time periods. From Jan. 1, 1991, through Sept. 30, 2008, the S&P 500 produced an average annualized return of 9.57%. For the same period, RevenueShares' backtested data show that RWL would have returned 12.03%. "Any short-term deficiencies in performance tend to be eliminated over a time horizon of three years or more," said O'Hara.
As would be expected, the RevenueShares' weighting system produces a different set of top holdings compared with market-cap-weighted ETFs. RWL has top holdings that include Wal-Mart ( WMT), ExxonMobil ( XOM), Chevron ( CVX), ConocoPhillips ( COP) and JPMorgan ( JPM). The SPDR S&P 500 ETF ( SPY), which has the same components as RWL but uses a market-cap-weighted approach, has ExxonMobil, General Electric ( GE), Proctor & Gamble ( PG), Microsoft ( MSFT) and Johnson & Johnson ( JNJ) as its top-five holdings. In coming months, RevenueShares will be rolling out sector-focused ETFs. The firm has filed nine that have been approved by the SEC, two of which may be released by the end of the year, O'Hara said. Market turbulence may provide an opportunity for RevenueShares funds, O'Hara said. "When the market is going straight up, people don't want to change what they have been doing," he said.