This is one of a series of articles discussing smart beta ETFs. Other smart beta articles you can read:
A fundamental ETF is a so-called smart beta ETF that follows an index that selects stocks to buy using some fundamental measure about a company, such as the company's total revenue, or total stockholders equity, or debt to equity ratio. In the investing world, the term "fundamental" generally refers to information about a company that you can obtain from the company's financial statements. Some fundamental indexes also weight the stocks they are holding not on each stock's market capitalization but instead using each stock's total sales revenue, or some other fundamental measure of a company's size.
The idea is to select "good companies" based on each company's financial statements. Proponents of fundamental indexes believe that traditional stock market indexes that select and weight stocks using each company's market capitalization end up holding too many stocks that are "overvalued" or "overhyped".
We end up classifying most fundamental ETFs as "multi-factor" ETFs, because many fundamental ETFs select stocks using some measure of the company's earnings, which is the quality factor, or they select stocks with dividends.
The number of fundamentally weighted ETPs in our database:
| Category | Count |
|---|---|
| Global Equity | 12 |
| US Equity | 27 |
| Total | 39 |
| Year of Inception | Count |
|---|---|
| 2005 | 2 |
| 2006 | 2 |
| 2007 | 4 |
| 2008 | 1 |
| 2011 | 2 |
| 2013 | 7 |
| 2014 | 2 |
| 2015 | 1 |
| 2016 | 2 |
| 2017 | 5 |
| 2018 | 5 |
| 2019 | 3 |
| 2020 | 3 |
| Total | 39 |
More and more ETFs are being launched that combine fundamental factors with other investment factors:
| Number of Factors Used | Count |
|---|---|
| 1 | 1 |
| 2 | 9 |
| 3 | 15 |
| 4 | 12 |
| 5 | 2 |
| Total | 39 |
The fundamental ETFs use different approaches, so let's run through a few examples of what they are doing.
FNDB, the Schwab Fundamental U.S. Broad Market Index ETF, tracks the Russell RAFI U.S. index, which selects and weights stocks using the average of three fundamental measures of company size: retained operating cash flow, adjusted sales, and dividends plus buybacks. FNDB is very much a "multi-factor" ETF, because by selecting stocks based on retained operating cash flow and dividends it is using the "quality" factor, while also selecting stocks based on dividends plus stock buybacks. FNDB also is using an alternate weighting scheme.
RWL, the Revenue Shares Large Cap Fund ETF, tracks the S&P 500 but weights the stocks using each company's top line revenue rather than market capitalization. It is not immediately clear what the effect of the alternate weighting scheme really is, but data provided by RWL's website as of 12/31/2016 shows a definite tilt towards value:
| Measure | RWL | SPY |
|---|---|---|
| Price/Earnings Ratio | 17.70 | 20.16 |
| Price/Sales Ratio | 0.81 | 1.98 |
| Price/Book Ratio | 2.59 | 2.90 |
| Price/Cash Flow Ratio | 10.11 | 13.02 |
FNDB and RWL are good examples of the challenge investors face when looking at smart beta ETFs:
One thing to always worry about with these smart beta ETFs is the unintended factor tilts that occur. RWL weights the S&P 500 using top line revenue. Is that really a good thing? The data provided by RWL's website clearly shows a value tilt, but it is hard to know what other factor tilts occur by doing this. Quality is one of the most well documented factors -- all things being equal, the stocks of highly profitable companies tend to outperform over long periods of time. Does ranking the S&P 500 by top line revenue unintentionally reduce your exposure to the "quality" factor? It is hard to know.
Similarly, what happens to RWL's exposure to the "size" factor? By looking at the Factsheets from RWL and SPY as of 12/31/2016, you can determine that RWL is skewing towards smaller size companies within the S&P 500: RWL's average market capitalization at 12/31/2016 was $117.01 billion, compared to $151,958.00 billion for SPY. That's probably a good thing, as RSP, which equal weights the S&P 500, has outperformed SPY over a long time period, mostly because the equal weighting tilts its holdings towards smaller sized companies in the S&P 500.
Both FNDB and RWL have decent track records so far, so we don't want to sound like we are being too critical. We are just trying to illustrate the difficulties associated with analyzing smart beta ETFs. Especially since every one seems to use a slightly different approach.
Here are the fundamental ETFs that use fundamental factors as an investment factor, if you want to read some examples of the approaches taken by fundamental ETFs:
| Symbol | Description | Inception Date | Category |
|---|---|---|---|
| SPHQ | Invesco S&P 500 Quality Portfolio ETF | 12/06/2005 | US Equity |
| PRF | FTSE RAFI US 1000 Portfolio ETF | 12/19/2005 | US Equity |
| FTCS | First Trust Capital Strength ETF | 07/06/2006 | US Equity |
| PRFZ | Invesco FTSE RAFI US 1500 Small-Mid Portfolio ETF | 09/20/2006 | US Equity |
| IDHQ | Invesco S&P International Developed Quality ETF | 06/13/2007 | Global Equity |
| PXF | Invesco FTSE RAFI Developed Markets ex-U.S. Portfolio ETF | 06/25/2007 | Global Equity |
| PDN | Invesco FTSE RAFI Developed Markets ex-U.S. Small-Mid Portfolio ETF | 09/27/2007 | Global Equity |
| PXH | Invesco FTSE RAFI Emerging Markets Portfolio ETF | 09/27/2007 | Global Equity |
| RWL | Oppenheimer Large Cap Revenue ETF | 02/22/2008 | US Equity |
| HDV | iShares Core High Dividend ETF | 03/29/2011 | US Equity |
| SCHD | Schwab U.S. Dividend Equity ETF | 10/20/2011 | US Equity |
| QUAL | iShares MSCI USA Quality Factor ETF | 07/16/2013 | US Equity |
| FNDA | Schwab Fundamental U.S. Small Company Index ETF | 08/15/2013 | US Equity |
| FNDB | Schwab Fundamental U.S. Broad Market Index ETF | 08/15/2013 | US Equity |
| FNDC | Schwab Fundamental International Small Cap Company Index ETF | 08/15/2013 | Global Equity |
| FNDE | Schwab Fundamental Emerging Markets Large Company ETF | 08/15/2013 | Global Equity |
| FNDX | Schwab Fundamental U.S. Large Company Index ETF | 08/15/2013 | US Equity |
| FNDF | Schwab Fundamental International Large Company Index ETF | 08/15/2013 | Global Equity |
| RDVY | First Trust Rising Dividend Achievers ETF | 01/06/2014 | US Equity |
| IVAL | ValueShares International Quantitative Value ETF | 12/16/2014 | Global Equity |
| IQLT | iShares MSCI Intl Dev Quality Factor ETF | 01/13/2015 | Global Equity |
| PY | Principal Shareholder Yield Index ETF | 03/21/2016 | US Equity |
| EYLD | Cambria Emerging Shareholder Yield ETF | 07/13/2016 | Global Equity |
| XSHQ | Invesco S&P SmallCap Quality Portfolio ETF | 04/07/2017 | US Equity |
| VSDA | VictoryShares Dividend Accelerator ETF | 04/17/2017 | US Equity |
| CSML | IQ Chaikin U.S. Small Cap ETF | 05/20/2017 | US Equity |
| SDVY | First Trust SMID Cap Rising Dividend Achievers ETF | 11/02/2017 | US Equity |
| JQUA | JPMorgan U.S. Quality Factor ETF | 11/09/2017 | US Equity |
| IUS | Invesco Strategic US ETF | 09/12/2018 | US Equity |
| IUSS | Invesco Strategic US Small Company ETF | 09/12/2018 | US Equity |
| ISEM | Invesco Strategic Emerging Markets ETF | 09/12/2018 | Global Equity |
| DSTL | Distillate U.S. Fundamental Stability & Value ETF | 10/24/2018 | US Equity |
| IQIN | IQ 500 International ETF | 12/13/2018 | Global Equity |
| VRAI | Virtus Real Asset Income ETF | 02/08/2019 | US Equity |
| FOVL | iShares Focused Value Factor ETF | 03/21/2019 | US Equity |
| RAFE | PIMCO RAFI ESG U.S. ETF | 12/19/2019 | US Equity |
| DEEP | Roundhill Acquirers Deep Value ETF | 06/22/2020 | US Equity |
| KVLE | KFA Value Line Dynamic Core Equity Index ETF | 11/24/2020 | US Equity |
| DFNV | TrimTabs Donoghue Forlines Risk Managed Innovation ETF | 12/08/2020 | US Equity |
All data is a live query from our database. The wording was last updated: 02/23/2018.
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