Stealth ETF Can Potentially Deliver Big Results

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As more and more ETFs hit the market, it becomes difficult for some investors and advisors to grasp the investment theses behind some of the more innovative product offerings. While the last few years have seen a surge in the number of “plain vanilla” ETFs, there has also been a big jump in products that employ unique strategies to generate superior returns. The Claymore/Sabrient Stealth ETF (STH) is one such fund, bringing a unique perspective by focusing on companies that have limited Wall Street analyst coverage and thus may be ‘flying under the radar’ of many investors.

Sometimes Less Is More

Large cap companies at the core of many investor portfolios often maintain large F-117 Nighthawk Stealth Fighteranalyst followings (at last count Apple (NASDAQ:AAPL) had 32 analysts following the company) and are thoroughly examined by Wall Street. With a small army of analysts following a firm, no stone is likely to go unturned, and anything and everything about the company is likely to be instantly disseminated. This would generally suggest that the fair value of the company is more likely to be known and reflected in the market price at any given time. However, a company with a single analyst or even one without analyst coverage may be far less efficient than blue chips, potentially presenting an opportunity to profit from a lack of quality information about a business.

When the first analyst starts tracking a company, it often leads to a jump in stock price, since this development suggests to the market that the company has “made it” and is now worthy of more attention (and scrutiny). Analysts can also have a large impact on a stock price with a stock downgrade, a negative development that often sends shares plummeting. And while many take equity analyst forecasts with a grain of salt, performance relative to these figures often sparks big moves. “The best use of these numbers is in comparing actual results", writes the Financial Times. “Stock prices react each quarter to the slightest shortfall or overachievement in results. And they can respond precipitously to modifications in analysts’ earnings forecasts.”

Inside The Stealth ETF

The Stealth Index is comprised of approximately 150 stocks that have little or no Wall Street analyst coverage (no more than two analysts). The universe of potential components includes approximately 2,100 listed companies without limitations on market capitalization, but which are mostly small cap and micro cap companies with capitalizations under $3.5 billion. In addition, all potential index members whose financials suggest the increased likelihood of aggressive accounting practices (based on measurements that are a component of the index provider’s proprietary methodology) are excluded from the index. Each company is then ranked using a 100% quantitative rules-based methodology that includes composite scoring of several growth-oriented, multi-factor filters, and is sorted from highest to lowest. The 150 highest-ranking companies are chosen and given a modified equal weight in the portfolio.

This produces the Claymore/Sabrient Stealth ETF, the first and thus far only ETF that focuses on neglected equities. Although the fund is open to all market cap levels and even has some large cap stocks in its portfolio, it is by nature a small cap fund with an average market cap of $812 million. The fund is currently heavily weighted towards the financials, industrials, and consumer discretionary sectors, which compose more than half of the fund. STH is also skewed towards value equities, with a dividend yield of 3.78%. STH has an expense ratio of 0.60% and it is up 16% in 2009.

Potential Benefits

By focusing on neglected equities, STH has the potential to deliver big results in many ways. Companies on which major banks initiate coverage are likely to be included, and could see a jump from the increased Wall Street attention. Moreover, investors who rely on equity analysts to make their buy and sell decisions will likely steer clear of most stocks held by this ETF, perhaps penalizing these companies for their lack of popularity and depressing prices below the intrinsic value.

STHDisclosure: No positions at time of writing.

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