What Are They?
- Quant strategy ETFs use pre-defined rules to pick stocks. The rules may use fundamental criteria, such as "overweight stocks with low P/E ratios", technical criteria, such as "overweight stocks that are trading at a 52 week high", or a mixture of the two.
- Quant strategy ETFs may be similar to Fundamental Index ETFs, which track an index of stocks ranked by fundamental criteria, such as book value, income, cash flow and dividends. The difference is that Quant Strategy ETFs may mix in techical factors, may not reveal the underlying rules to investors, and typically hold a limited number of stock. In contrast, Fundamental Index ETFs tend to hold all the stocks in an index, but ascribe different weightings to them based on fundamental criteria.
Why & How To Use Them
- Use these ETFs instead of traditional broad index ETFs if you believe that quantitative, rules-based stock selection will outperform a market cap weighted or equal cap weighted index.
What to Look Out For
- Compared to broader index ETFs, specialty ETFs such as quant strategy ETFs tend to have higher expense ratios and wider buy-sell spreads (which makes them more costly to purchase and sell).
- The quarterly recalibration of the stock baskets underlying these ETFs leads to higher stock turnover and therefore potentially higher trading costs and lower tax efficiency.
- It's harder to build a diversified portfolio if you don't know which stocks your ETFs contain, as that opens the possibility of overlapping holdings between ETFs. Traditional index ETFs are easier to manage.
- Articles on these ETFs: First Trust, JPMorgan Team Up to Launch First 130/30 ETN (Murray Coleman), Did Specialty ETFs Provide a Cushion From the Fall? (Matt Hougan), Timing is Everything: PowerShares Launches 'Relative Strength' ETF (Matt Hougan).
- More on PowerShares: Active Indexes Drive PowerShares' ETFs (Sam Subramanian), PowerShares: Growing Assets But With High Expense Ratios (Mick Weinstein).
- As an alternative to these ETFs, consider US Total Market and Broad ETFs.
This page is part of The Seeking Alpha ETF Selector which sorts ETFs by type, highlights how to use them and what to look out for, and provides links to articles that discuss key issues for investors.