By Eric Dutram
As the economy has continued to weaken in recent months, investors have pushed towards safer choices in a number of sectors of their portfolios. Generally speaking, funds in a few select, defensive sectors tend to benefit in this environment, namely those in the health care, utilities, and consumer staples niches. Yet, while some sectors have held up pretty well in this turmoil, gains have been harder to come by in the usually safe consumer staples space. After all, people have to buy these products regardless of the broader economic situation, so one would assume that their share prices would be relatively strong, however, this has not been the case so far this year. In fact, most products are down in year-to-date terms in the Consumer Staples ETFdb Category as nine of the 13 funds that have been around since the beginning of the year are in the red. With that being said, a few have managed to thoroughly crush the competition, most notably, First Trust’s Consumer Staples AlphaDEX Fund (FXG).
FXG has, so far in 2011, beaten the rest of the sector pretty badly as the product has gained close to 7.3% on the year. This compares very favorably with the vast majority of the funds in the space, and handily beats the top dog in the category, the Consumer Staples Select Sector SPDR Fund (XLP), which has gained 1.3% in comparison over the same time frame. However, it doesn’t appear as if this is a short term trend as FXG is also the top performing ETF in the space when analyzed from both the trailing one and three year periods as well. In fact, FXG has outperformed all other funds in the space by at least 700 basis points in the one year time frame, and close to 400 over the year period as well. These large gaps have more than made up for FXG’s hefty fees – costs are currently 0.7% a year – which are, in some cases, close to four times higher than the low cost products in the space. With that being said, given the history of outperformance, even cost conscious investors may want to take a closer look at this product to see if it fits with their investment goals [see Three Pure Play Consumer ETFs].
AlphaDEX: Under The Hood
Unlike most ETFs in the space, FXG doesn’t track a pure market cap weighted cap benchmark. Instead, the fund follows the StrataQuant Consumer Staples Index which consists of all the consumer staples firms in the Russell 1000 Index. The company then ranks all of the stocks in this subset, on a quarterly basis, on a number of factors both from a growth and value perspective. From a growth standpoint, all of the stocks are rated on three, six and 12-month price appreciation, sales to price and one year sales growth, while for value, the components are rated on metric such as book value to price, cash flow to price and return on assets.
Once all of the stocks are ranked, the bottom 25% are eliminated from inclusion in the fund while the remaining 75% are broken up into quintiles. The top rated quintile makes up 33.3% of the total weight, while the following segments are weighted 26.7%, 20.0%, 13.3% and 6.7%. All stocks are weighted evenly in the quintiles, but since the top quintile makes up close to five times as much of the holdings as the lowest quintile, top ranked companies do make up a bigger portion of the overall index. In total, this gives the fund about 36 companies in its basket with heavy exposure going to mid and large cap firms [see all the First Trust ETFs here].
Reasons For The Difference
Obviously, this method produces a very different risk/return profile than cap weighted products and is the primary reason for such a variation in performance between FXG and cap weighted products over the years. This is further confirmed by a quick look at the top holdings of FXG and comparing this to XLP and their components’ returns on a year-to-date basis. Below, take a look at the most popular fund in the space, XLP, and its top three holdings:
Now, compare this to FXG and the performance of its current top holdings:
As you can see from the charts above, the returns of some of the top components has been vastly different between the two products so far in 2011. FXG’s heavy focus on small and mid caps, compared to XLP’s large cap oriented approach, has certainly paid off as a number of small staples firms have gained significantly in recent months. While it is true that FXG may not have had these firms in its portfolio for the entire year, and that a number of other securities in the fund performed significantly worse than these top three components, the fact that the fund’s current top three weightings have gone to such outperformers is certainly encouraging.
Additionally, investors should note that FXG remains far less concentrated from a top holdings perspective as its top three picks barely match the weighting given to PG by the State Street product. With that being said, investors should realize that XLP isn’t all bad by any stretch as the product offers investors much higher levels of liquidity and more holdings than its First Trust counterpart. XLP also is less prone to market movements than FXG, as represented by beta, and the fund pays out a better dividend yield as well. This should suggest that XLP may be more of a "value play" in uncertain times and is probably less likely to be impacted by wild market swings. Nevertheless, if investors can get past FXG’s relatively high fees and look at its stellar performance history, this may be an interesting product to take a closer look at for those seeking more exposure in the consumer staples space.
Disclosure: Long PM.
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