Excerpt from our One Page Annotated Wall Street Journal Summary (receive it by email every morning by signing up here):
FUND TRACK: Not All Index ETFs Are What They Seem to Be
Summary: Some new Exchange Traded Funds in that burgeoning industry operate more like stock-picking mutual funds than the indexed or segment approach that has generally characterized ETFs. New offerings from PowerShares aim to find stocks 'that have the greatest potential for capital appreciation,' provoking criticism from traditional indexing advocates like Vanguard's John Bogle. Critics further allege that the new funds use the term 'index' merely to gain SEC approval: 'The SEC is hesitant to bless any ETFs identifying themselves as "actively managed" ETFs that don't track indexes, because they are concerned about transparency and trading issues, among other things.' The First Trust DB Strategic Value Index Fund (FDV) is an example: It follows a Deutsche Bank index/screen that searches for 40 stocks with low earnings-based valuation among the largest S&P 500 companies. The ETF firms have marketed the new funds based on 'back-tested' data, but a WSJ look a bit further back than the funds go indicates they haven't always performed as strongly against the traditional S&P 500 index as claimed.
Comment on related stocks/ETFs: The main criticism is that these ETFs have 'the goal of outperforming the market' like a money manager, but who says 'the market' should be defined as the S&P 500? Every index has its flaws; the key issue may be the commitment of the managers to objective criteria. Market Participant applauds the new First Trust ETF criticized in the WSJ article. Robert Arnott's fundamental indexes, tracking factors like sales, cash flow and dividends, are among the new funds' benchmarks --- we've had extensive coverage of this approach on our ETF site, including an article by Arnott himself and cogent criticism from Tom Coyne and the Accidental Consultant.