NEW YORK ( TheStreet) -- Developers of exchange-traded funds comb through academic research, seeking strategies that have delivered outsized returns.
Popular ETFs with academic pedigrees focus on stocks with high dividends and low volatility. Not all the strategies have succeeded. What worked in the past does not necessarily succeed in the future. But a handful of ETF strategies have compiled compelling five-year records, topping the S&P 500 by more than 5 percentage points.
The strategies are all based on well-documented anomalies that have persisted for years. But it seems unlikely that the ETFs will top the benchmarks by such wide margins in the future. As money managers notice the successes, more competitors are likely to appear and bid up the prices of target stocks.
Among the strongest performers is First Trust US IPO. During the past five years, the ETF returned 32.1% annually, compared with 25.8% for the S&P 500, according to Morningstar. The ETF outperformed the S&P 500 in each of the past five years.
First Trust IPO aims to exploit the mixed patterns of initial public offerings. As investors discovered during the Internet bubble of the late 1990s, many IPOs become excessively hyped, surging on their first trading days and then languishing. But some IPOs prove to be terrific investments, says Josef Schuster, who designed the index that the ETF tracks.
In his research, Schuster found that most IPOs suffered double-digit losses in their first four years of trading. But the top 25% of new companies recorded big gains, as the best young companies won favor on Wall Street by delivering strong earnings. When all the winners and losers were lumped together, the average result surpassed the market by a wide margin.
To improve its odds of success, Schuster's benchmark takes only the 100 largest IPOs that started trading in the past four years. That eliminates some small shaky deals that may never succeed.
In addition, the benchmark excludes stocks that showed peculiar patterns in their first few days of trading. Say a stock doubles on its first trading day. The IPO would be left out of the index because such skyrocketing stocks tend to sink in later weeks.
The ETF had particularly strong performance in the past 12 months, returning 41.9% and topping the S&P 500 by 16 percentage points. Holdings that soared in the past year include Facebook (FB) and Tesla Motors (TSLA).