Choosing an ETF Indexing Strategy

There’s an ongoing debate about indexing when it comes to ETFs, and each side continually brings out new evidence and information to bolster their arguments.

Proponents of fundamental indexing contend that mutual funds and ETFs based on the S&P 500 are flawed in their designs, reports John Spence for The Wall Street Journal. The S&P 500 can be top-heavy with companies that have large market value, adding weight to the stocks.

• SPDR S&P 500 ETF (SPY): up 3.6% year-to-date

The new breed of funds that seek to remedy this issue are based on indexes that weight stocks by high dividend yields, low share-price-to-earnings ratios and various other factors. It is thought that these types of funds are less risky and provide better long-term performance.

• PowerShares FTSE RAFI US 1000 Portfolio (PRF): up 10.6% year-to-date

• WisdomTree LargeCap Dividend (DLN): down 3.3% year-to-date

According to Rob Arnott, founder of Research Affiliates LLC and the father of fundamental indexing, the market does tend to incorrectly value stocks, and the solution should be to weight stocks by book value, cash flow, sales and dividends. Research Affiliates also readjusts its index annually by shifting its ETF into sectors with strong fundamentals but lower stock prices. The effect is to allow investors the benefit of capitalizing when the markets shift.

There are skeptics of this new methodology. Fundamental indexing could tend to lean toward “value” investing. But proponents claim fundamental-indexing strategies perform better in environments such as after market bubbles burst, not speculative markets.

Max Chen contributed to this article.

Comments

[bigmoney:]

PRF trails SPY sometimes, and leads other times, at least according to my yahoo chart. Seems to be a wash in the end. Or maybe i am not comparing apples to apples?

Jul 07 12:52 AM