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AlphaDEX Alternatives to Cap-Weighted ETFs Prove Their Mettle

December 13, 2012 12:43 pm
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AlphaDEX Alternatives to Cap-Weighted ETFs Prove Their Mettle

Among the prominent trends in the ETF industry this year has been the realization by advisors, investors and traders that traditional cap-weighted funds are not always the best when it comes to returns. Still, most equity-based ETFs are just that: Weighted by the market values of the funds’ underlying components.

Traditional cap-weighted methodologies are particularly common with broad market ETFs such as the SPDR S&P 500 (NYSE: SPY) and the PowerShares QQQ (NASDAQ: QQQ). However, there are alternative strategies that have proven to be solid in terms of delivering returns with FirstTrust’s AlphaDEX suite being home to some broad market fare that investors may want to consider over more common cap-weighted fare.

In a research note out today, Street One Financial’s market technician David Chojnacki highlights three AlphaDEX ETFs that have represent valid alternatives to traditional broad market ETFs.

One example is the First Trust Large Cap Core AlphaDEX Fund (NYSE: FEX), which tracks the Defined Large Cap Core Index. That index screens the S&P based on a variety of growth and value factors, including three, six and 12-month price appreciation, sales to price, one year sales growth, book value to price, cash flow to price and return on assets, according to First Trust.

The result is an ETF with the top 75 percent of the S&P 500 and a fund that is far from cap-weighted as GameStop (NYSE: GME), Ford (NYSE: F) and Aetna (NYSE: AET) are among FEX’s top-10 holdings. What is important to note, as Chojnacki points out, is that since coming to market in May 2007, FEX has outperformed SPY. In fact, the First Trust offering has generated positive returns over that time while SPY is in the red. Today, FEX has almost $345 million in assets under management.

A similar situation is found with the First Trust Mid Cap Core AlphaDEX Fund (NYSE: FNX) and the SPDR S&P MidCap 400 ETF (NYSE: MDY).

FNX’s approach mirrors that of FEX, but in this case the index tracked is the Defined Mid Cap Core Index and the ETF’s constituents are the top 75 percent of the S&P MidCap 400 Index. FNX came to market on the same day in May 2007 as FEX and its ability to outperform rival funds such as MDY has been impressive.

Since its debut, FNX has outpaced MDY by over 950 basis points, though MDY has been the winner over the past 12 months. FNX has over $303 million in assets.

The scenario repeats at the small-cap level as the First Trust Small Cap Core AlphaDEX (NYSE: FYX) has outpaced the iShares Core S&P Small-Cap ETF (NYSE: IJR) since May 2007. FYX’s constituents are pulled from the S&P SmallCap 600 Index, the same index tracked by IJR. Since inception, “FYX has outpaced the S&P 600 SmallCap Index 11.65% versus 8.08%,” according to Chojnacki.

“As one might imagine, a fundamentally weighted index would vary significantly head to head against a market cap weighted index (calculated by share price times shares outstanding) in terms of individual equity weightings. . Since inception in 2007, based on live returns in these ETFs, First Trust has demonstrated thus far that notable value can be added in an alternative weighting methodology to the market cap,” said Chojnacki.

For more on AlphaDex ETFs, click here.

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