I first profiled the First Trust AlphaDEX sector ETFs in a Dec. 2014 article "Evaluating The Performance Of The First Trust AlphaDEX Sector ETFs". First Trust is currently the 7th-largest ETF provider, with $33B in assets under management.
In that article, I described the construction of the AlphaDEX methodology. Briefly, AlphaDEX indices are fundamental-weighted rather than market capitalization-weighted. The methodology ranks stocks in the universe according to their value or growth scores, eliminates the bottom 25% of ranked stocks, and then weights the remaining companies by their score, with higher scoring stocks getting higher weights in the index.
First Trust provides 9 AlphaDEX sector ETFs, as shown in the table below. Also shown are the corresponding SPDR sector ETFs, which are well-known and can be considered as benchmarks for this exercise.
|First Trust AlphaDEX||SPDR|
|First Trust Consumer Discretionary AlphaDEX Fund||(NYSEARCA:FXD)||Consumer Discretionary Select Sector SPDR Fund||(NYSEARCA:XLY)|
|First Trust Consumer Staples AlphaDEX Fund||(NYSEARCA:FXG)||Consumer Staples Select Sector SPDR Fund||(NYSEARCA:XLP)|
|First Trust Energy AlphaDEX Fund||(NYSEARCA:FXN)||Energy Select Sector SPDR Fund||(NYSEARCA:XLE)|
|First Trust Financials AlphaDEX Fund||(NYSEARCA:FXO)||Financial Select Sector SPDR Fund||(NYSEARCA:XLF)|
|First Trust Health Care AlphaDEX Fund||(NYSEARCA:FXH)||Health Care Select Sector SPDR Fund||(NYSEARCA:XLV)|
|First Trust Industrials/Producer Durables AlphaDEX Fund||(NYSEARCA:FXR)||Industrial Select Sector SPDR Fund||(NYSEARCA:XLI)|
|First Trust Materials AlphaDEX Fund||(NYSEARCA:FXZ)||Materials Select Sector SPDR Fund||(NYSEARCA:XLB)|
|First Trust Technology AlphaDEX Fund||(NYSEARCA:FXL)||Technology Select Sector SPDR Fund||(NYSEARCA:XLK)|
|First Trust Utilities AlphaDEX Fund||(NYSEARCA:FXU)||Utilities Select Sector SPDR Fund||(NYSEARCA:XLU)|
The expense ratio of the First Trust AlphaDEX funds is 0.63% (down from 0.70% in Dec. 2014). This is 0.49% higher or over four times the expense ratio of the SPDR funds at 0.14% (down from 0.16% in Dec. 2014). It is pleasing to see that both ETF providers have decreased their fund fees since my last article about 18 months ago.
The previous analysis found that on average, the AlphaDEX sector ETFs outperformed the SPDR sector ETFs by 1.9% annualized over the 7.5-year period since their inception. As this value is net of fees, this indicates that the AlphaDEX methodology has succeeded in providing superior returns compared to the index.
About 18 months on, do the AlphaDEX funds still outperform?
The following charts show the total return performance of the AlphaDEX ETFs over their benchmark SPDR ETFs since Jan. 1, 2015.
From the charts above, we can see that only 3 out of the 9 AlphaDEX sector ETFs have outperformed their benchmarks. The AlphaDEX ETFs that outperformed were in the consumer staples, financials, and materials sectors.
The data are summarized in the table and chart below.
Unfortunately, the numbers show that the AlphaDEX ETFs have severely underperformed their benchmarks over this time period, with an average underperformance of -5.4%.
Discussion and conclusion
The AlphaDEX methodology has performed quite poorly over the past 1.5 years. While I was never a fan of these funds, their poor recent performance has soured my impression of the AlphaDEX methodology even more.
One thing that I dislike about the AlphaDEX methodology is the use of the growth factor in stock selection. The growth factor has never really been an academically validated factor, unlike value or momentum. In a Dec. 2013 article "Foundations of Factor Investing", MSCI present data showing that growth stocks have not outperformed the market over long periods. (Addendum: having studied the AlphaDEX methodology in more detail, I have realized I have made an error. The "growth" factor does include price momentum, but it also includes one-year sales growth as well.)
Additionally, the AlphaDEX methodology has a feature whereby stocks that are categorized as core/blend (rather than pure growth or pure value) receive the higher of their growth or value scores for ranking purposes. However, evidence from the Alpha Architect has suggested that when combining value and momentum factors, it is better to construct a portfolio consisting of 50% of the best value stocks and 50% of the best momentum stocks, rather than a blended strategy that chooses stocks that exhibit both value and momentum characteristics. In this respect, the AlphaDEX methodology might benefit from eliminating the core/blend class altogether.
In a nutshell: I would not invest in the AlphaDEX sector ETFs.
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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.