I'm going to discuss three funds (2 ETFs and 1 ETN) that have returned 20% or more for the past 1, 3 and 5 years. And they've done it without any leverage, derivatives or complex trading schemes. Two of the three are large-cap funds holding stocks you will recognize immediately. One is a mid- to small-cap fund.
Each of the three has its own unique approach to adding alpha. And, add alpha they have: From a low of 1.51 to a high of 10.23 for the past three to five years.
How do they do it? The most interesting thing about the generation of all this alpha is that it was accomplished with investing principles that can be summarized in a sentence for each. A sentence that can be readily understood by the least quantitatively inclined investor. The underlying strategies are not built on high-tech concepts. Rather they are based on concepts that approach the intuitive, albeit solidly backed by serious academic research.
The funds and their investment philosophies:
- Guggenheim Spin-Off ETF (CSD) comprises approximately 40 (currently 24) securities that have been spun-off within the past two years, but not more recently than six months prior to rebalancing date.
- Invesco PowerShares Buyback Achievers ETF (PKW) invests in U.S. companies that have repurchased 5% or more of its outstanding stock for the trailing 12 months. It currently holds stock in 205 companies.
- Morningstar Wide Moat Focus ETN (WMW) holds 20 stocks from those determined by Morningstar to have wide moats. The 20 are those that have the highest ratio of fair value to stock price as determined by Morningstar's analysts.
As one might expect from the descriptions, the holdings of these funds have little in common. Only a single company appears in the top ten holdings of more than one:
Top Ten Holdings
Exelis Inc. (XLS)
General Electric Co. (GE)
Lumos Networks Corp. (LMOS)
Amgen Inc. (AMGN)
Franklin Resources Inc. (BEN)
Kraft Foods Group Inc. (KRFT)
Oracle Corporation (ORCL)
Coviden PLC (COV)
AMC Networks Inc. (AMCX)
American International Group Inc. (AIG)
Medtronic Inc. (MDT)
Huntington Ingalls Industries Inc. (HII)
Time Warner Inc. (TWX)
Allergan Inc. (AGN)
WPX Energy Inc. Class A (WPX)
Lowe's Companies Inc. (LOW)
Bank of NY Mellon Corp. (BK)
Fortune Brands Home & Security Inc. (FBHS)
Twenty-First Centy Fox (FOX)
Oracle Corp. (ORCL)
Starz Inc. Class A (STRZA)
ITC Holdings (ITC)
ADT Corporation (ADT)
Time Warner Cable Inc. (TWC)
Coca-Cola Co. (KO)
Marriott Vacations Worldwide Corp. (VAC)
Travelers Companies, Inc. (TRV)
CSX Corp. (CSX)
The sustained performance of these three funds is impressive indeed, and they have accomplished this performance without having taken on excessive risk. The table below lists return and some portfolio metrics for the three funds and SPY as a benchmark.
Performance and Risk
Return (Annualized %)
Return (Cumulative %)
Return (Annualized %)
Return (Cumulative %)
One readily notes the impressive returns, but let's also pay attention to the other values here. Sharpe ratios (with one exception) beat the benchmark impressively. More interesting are the Sortino ratios, which measure return against downward volatility, where each solidly outclasses the index fund. These values affect how these funds can enhance a total portfolio in more ways than their obviously welcome contribution to total return.
The chart below plots 5-year returns through November 2013 for a portfolio comprising the three funds. The portfolio was optimized for maximum Sortino ratio within constraints that each fund comprised no more than 40% and no less than 25% of the total portfolio. The chart compares this optimized portfolio (green line) with an equal-weight portfolio (blue line).
The three funds combined beat the SPY benchmark by nearly 100%. As you can see, the optimization exercise does add to the total return over 5 years, but it's only a modest increase.
Stats for the optimized portfolio are:
Here's a table summarizing key 3 and 5-year metrics for these funds, which helps to explain the somewhat counterintuitive performance behavior of the three funds in combination:
Notice that WMW, which has the lowest performance values, the lowest alpha and the lowest Sortino value, ends up being the highest weighted holding in the portfolio optimized as described above. Notice, too, that its presence in the portfolio does not, as one might expect, reduce returns appreciably. Indeed, increasing its weighting from 33% (the blue line for the equal-weighted portfolio in the chart above) to 40% (the green line) enhances portfolio return. This is almost certainly a function of the low r-squared value leading to moderation of downdraw for the total portfolio. Of course the fact that CSD, the best performing fund is also increased (although less so) helps drive performance, but another key is that PKW, which has the highest r-squared, is reduced to the minimum allowed weight. Interesting indeed, but the subject of another article.
Finally, let's take a look at the correlation matrix comparing each of the three funds and SPY as a proxy for a broad-market, large-cap portfolio.
Notice here that WMW is the least correlated with the other two funds and with the broader market index fund. In this regard, the fund has an attractive role to play in diversifying a broad-market portfolio. Also apparent is that PKW adds much less diversification to such a portfolio.
Each of these three funds has turned in consistently impressive results over an extended period of time. Any one of them would be a fine addition to a growth-oriented portfolio. In addition to sterling performance, two of the funds also provide quantitative enhancements to a broad-market equity portfolio. WMW adds meaningfully uncorrelated holdings within the large-cap asset class. We can see above how effectively its contribution works in a total portfolio. CSD adds high performance from the mid- to small-cap asset class, again adding meaningful diversification within the domestic equity asset class without sacrificing returns.
I'll close with some comments on possible alternatives to PKW. In preparing this article I wanted to stick with funds that had a history of at least 5 years, so I was not able to include a couple of other funds that share the buyback strategy of PKW: Cambria Shareholder Yield ETF (SYLD) and AdvisorShares TrimTabs Float Shrink ETF (TTFS). SYLD expands the concept beyond buybacks to include additional factors that enhance shareholder value including paying dividends and reducing debt. The interested reader may want to consider these as well. I discussed all three previously in an article on shareholder value ETFs here. Although lacking the 5+ year history of PKW, both of these have been posting impressive returns and either could be appropriate to fill the same place in a portfolio. I noted a preference for SYLD earlier; it remains my choice among shareholder-value/buyback ETFs.
As always, I remind readers that I am an individual investor doing my homework. I have no claims to professional expertise of any sort in stock evaluation. I am simply sharing my own research in the hope that it may be useful to others. Any actions a reader may want to take based on this research must necessarily include his or her own careful due diligence and full consideration of his or her individual goals and needs.