Analysis of John Hancock Multifactor ETFs
analysis, correlation, exchange-traded fund, factor investing, financial adviser, mutual fund

In September 2015, John Hancock Investments launched six strategic (smart) beta John Hancock Multifactor ETFs, with underlying indexes designed by Dimensional Fund Advisors LP (DFA). By now, the product suite has grown to a total of twelve ETFs, three “core” and nine “sector” ones.

Traditionally, DFA mutual funds were available only through advisors operating within the company’s program. With John Hancock Multifactor ETFs, retail investors can access DFA strategies without paying an advisory fee, which is typically 1% of assets under management (AUM). However, since DFA offers a large selection of mutual funds, it is not clear which of them can be replaced by the ETFs.

Let’s start with the John Hancock Multifactor Large Cap ETF (JHML). To identify the best candidates for substitution, we will use the correlation of rolling 52-week returns (conventionally, we would use rolling 36-month returns, but John Hancock ETFs have insufficient history). Although high correlations do not imply product identity, there are a good starting point for further analysis. Here are the correlations of DFA core and large-cap funds with JHML:

Correlations of DFA Large-Cap Funds with John Hancock Multifactor Large Cap ETF (JHML)

Of the candidate funds, the DFA US Large Cap Equity Portfolio (DUSQX) and DFA US Large Company Portfolio (DFUSX) had the highest correlation with JHML. Let’s see what total returns and traditional statistics looked like for the candidate funds and the ETF:

Total Return of DFA Large-Cap Funds and John Hancock Multifactor Large Cap ETF (JHML)

Indeed, the performance of DUSQX and DFUSX was similar to that of JHML, although the volatility of the ETF was slightly lower than that of the funds.

Next, let’s take a look at the John Hancock Multifactor Mid Cap ETF (JHMM). DFA does not offer an explicitly-named mid-cap fund, so we will try the core and small-cap funds. Here are their correlations with JHMM:

Correlations of DFA Core and Small-Cap Funds with John Hancock Multifactor Mid Cap ETF (JHMM)

Based on this criterion, the DFA US Core Equity 1 Portfolio (I) (DFEOX) and DFA US Core Equity 2 Portfolio (I) (DFQTX) were the best candidates for substitution.

Total Return of DFA Core Funds and John Hancock Multifactor Mid Cap ETF (JHMM)

The DFEOX tracked JMHH most closely, although at a lower annualized return and a slightly higher standard deviation.

Finally, let’s analyze the John Hancock Multifactor Developed International ETF (JHMD). This ETF was launched in mid-December 2016 and, as of this writing, does not have 52 weeks of history. Therefore, to determine its correlations with DFA International funds we will use a rolling 26-week period:

Correlations of DFA International Funds with John Hancock Multifactor Developed International ETF (JHMD)

The DFA International Core Equity Portfolio (I) (DFIEX) and DFA International Large Cap Growth Portfolio (DILRX) had the highest correlations with the ETF. The ETF most closely tracked the former fund:

Total Return of DFA International Funds and John Hancock Multifactor Developed International ETF (JHMD)

Although John Hancock Multifactor ETFs have a relatively short history, we have identified specific DFA mutual funds that these ETFs can effectively substitute. However, it should be noted that ETFs trade at market prices and not at net asset values (NAVs) as mutual funds do. Therefore, ETF premiums/discounts and spreads may negatively affect investors’ returns. Nevertheless, these ETFs are worth a consideration by those investors who like DFA’s multifactor strategies but do not want to pay recurring advisory fees to gain access to DFA mutual funds.

To learn more about the performance of John Hancock Multifactor sector ETFs, please register on our website.


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Analysis of Cambria ETFs (Part II)
analysis, exchange-traded fund

The previous post in this two-part series covered the three actively-managed products out of the five Cambria ETFs with a sufficiently long history. This post will focus on the remaining two index ETFs.

Let’s start with the analysis of the Cambria Foreign Shareholder Yield ETF (FYLD). According to the sponsor, the fund follows a proprietary index that

…consists of stocks with high cash distribution characteristics. The initial screening universe for this Index includes stocks in foreign developed countries with marketing capitalizations over $200 million. The Index is comprised of the 100 companies with the best combined rank of dividend payments and net stock buybacks, which are the key components of shareholder yield. The Index also screens for value and quality factors, including low financial leverage.

As in the case of actively-managed Cambria ETFs, the evaluation with begin in the first full calendar month since the fund’s inception and end in July 2016. Here is a chart with related statistics of the cumulative RealAlpha™ for the fund:

Cumulative RealAlpha™ for Cambria Foreign Shareholder Yield ETF (FYLD)

Similarly to its predecessors, the fund failed to outperform its reference ETF portfolio which had a slightly smaller volatility, measured as the standard deviation of monthly returns. The fund’s RealBeta™ was moderately higher than that of a broad-based domestic equity ETF.

The following chart and corresponding statistics show the constant composition of the reference ETF portfolio for the fund over the same period:

Reference Weights for Cambria Foreign Shareholder Yield ETF (FYLD)

The fund had major equivalent positions in the Schwab International Small-Cap Equity ETF (SCHC), WisdomTree International SmallCap Dividend Fund (DLS), First Trust Dow Jones Global Select Dividend Index Fund (FGD), iShares MSCI United Kingdom ETF (EWU), PowerShares DWA Industrials Momentum Portfolio (PRN), and Vanguard FTSE Europe ETF (VGK). The Other component in the chart collectively represents additional five foreign-stock ETFs covering the New Zealand, Japan, Australia, Spain and Mexico markets. The reference weights indicate a significant foreign small-cap equity tilt of the fund.

Lastly, we will evaluate the Cambria Global Value ETF (GVAL). The issuer states that this product implements a proprietary index which

…consists of stocks with strong value characteristics. The Index begins with a universe of 45 countries located in developed and emerging markets. […] The Index next separates the top 25% of these countries as measured by Cambria’s proprietary long term valuation metrics. The Index then screens stocks with market capitalizations over $200 million. The Index is comprised of approximately 100 companies.

The following chart and associated statistics depict the cumulative RealAlpha™ for the fund:

Cumulative RealAlpha™ for Cambria Global Value ETF (GVAL)

Compared to its reference ETF portfolio, the fund added a modest amount of value (mostly in the last four months of the analysis period), although the portfolio had a slightly lower volatility. The RealBeta™ of the fund was substantially higher than that of a broad-based U.S. stock ETF.

The following chart and statistics demonstrate the fixed membership and weights of the reference ETF portfolio for the fund:

Reference Weights for Cambria Global Value ETF (GVAL)

The fund had main equivalent positions in the iShares MSCI Italy Capped ETF (EWI), WisdomTree Europe SmallCap Dividend Fund (DFE), Guggenheim CurrencyShares® Euro Trust (FXE), iShares MSCI Poland Capped ETF (EPOL), iShares Latin America 40 ETF (ILF), and Global X MSCI Greece ETF (GREK). The remaining six ETFs in the above table, spanning the Spain, Brazil and Germany equities as well as international-corporate and emerging-markets bonds, collectively constitute the Other item in the above chart.

Conclusion

One of our previous posts outlined the benefits of similar analyses of iShares smart beta ETFs, which we will not repeat here for brevity. This evaluation of Cambria ETFs provides investors with similar insights.

Just like any other composite investment vehicles, Cambria ETFs change their holdings over time. Therefore, a question arises about the value of an analysis in which a static ETF portfolio is calculated from long-term data. The answer is to use a more advanced variant of Alpholio™ patented methodology, in which the membership of the reference ETF portfolio is still fixed but weights can fluctuate. Such a dynamic portfolio tends to more accurately track the analyzed fund over time.

For example, here is a chart with accompanying statistics of a reference ETF portfolio determined in that manner for the Cambria Shareholder Yield ETF (SYLD):

Reference Weights for Cambria Shareholder Yield ETF (SYLD) - Fine Fit

This gives a more accurate view of the fund’s recent average exposures.

If you would like to use our ETP Analysis Service to investigate similar products, please register on our website.


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Analysis of Cambria ETFs (Part I)
active management, analysis, exchange-traded fund

Cambria currently offers eight ETFs. Of those, five have a history longer than twelve calendar months, which is a minimum Alpholio™ requires to conduct an initial analysis. Of these remaining five products, three are actively-managed and two follow proprietary Cambria indices. This post, the first in a two-part series, focuses on the actively-managed Cambria ETFs. The second part will cover index-based funds.

We will evaluate each fund from the first full month since its inception through July 2016 using the simplest variant of the Alpholio™ patented methodology. This approach constructs a reference ETF portfolio with both fixed membership and weights that most closely tracks the returns of the analyzed fund. In essence, the reference ETF portfolio embodies average core exposures of the analyzed fund to various factors, indices and strategies over the analysis period. Since it constitutes a potential static substitute for the analyzed fund, i.e. it is an investment alternative, it also serves as a relevant performance benchmark for the fund. (Unlike with pure indices that are not investable, this real benchmark accounts for actual implementation costs.)

Let’s start with the oldest product, the Cambria Shareholder Yield ETF (SYLD). According to the firm, this actively-managed fund

…invests in 100 [U.S. listed] stocks with market caps greater than $200 million that rank among the highest in (a) paying cash dividends, (b) engaging in net share repurchases, and (c) paying down debt on their balance sheets.

Here is the resulting chart with statistics of the cumulative RealAlpha™ for the fund (to learn more about this and other performance measures, please visit our FAQ):

Cumulative RealAlpha™ for Cambria Shareholder Yield ETF (SYLD)

The fund did not not add value when compared to a reference ETF portfolio, which had a slightly lower volatility. The RealBeta™ of the fund was slightly higher than that of a broad-based domestic equity ETF.

The following chart with related statistics shows the constant composition of the reference ETF portfolio for the fund over the same evaluation period:

Reference Weights for Cambria Shareholder Yield ETF (SYLD)

The fund had major equivalent positions in the PowerShares BuyBack Achievers Portfolio (PKW; an index-based ETF), WisdomTree MidCap Dividend Fund (DON), Guggenheim S&P 500® Equal Weight Technology ETF (RYT), FlexShares Quality Dividend Index Fund (QDF), PowerShares Dynamic Market Portfolio (PWC), and First Trust Large Cap Value AlphaDEX® Fund (FTA). The Other component in the chart collectively represents additional six ETFs with smaller weights, listed in the above table.

It should be noted that one of the well-known investment analytics firms classifies SYLD into the mid-cap value category. While this may be based on the assessment of the fund’s individual holdings, our analysis shows that the fund had primarily large-cap exposures. As a matter of fact, the fund’s prospectus states that

Although the Fund generally expects to invest in companies with larger market capitalizations, the Fund may invest in small- and mid-capitalization companies.

Next, we will analyze the Cambria Global Momentum ETF (GMOM). According to its issuer, the fund

…intends to target investing in the top 33% of a target universe of approximately 50 ETFs based on measures of trailing momentum and trend. The portfolio begins with a universe of assets consisting of domestic and foreign stocks, bonds, real estate, commodities and currencies.

The following chart with corresponding statistics illustrates the cumulative RealAlpha™ for the fund:

Cumulative RealAlpha™ for Cambria Global Momentum ETF (GMOM)

This fund also failed to add value compared to its reference ETF portfolio of a somewhat lower volatility. However, its RealBeta™ was only about one-third that of the broad-based stock market.

The following chart with associated statistics depicts the fixed composition of the reference ETF portfolio for the fund over the same analysis period:

Reference Weights for Cambria Global Momentum ETF (GMOM)

The fund had major equivalent positions in the PowerShares Build America Bond Portfolio (BAB; an index-based ETF), SPDR® Nuveen S&P High Yield Municipal Bond ETF (HYMB), iShares Edge MSCI USA Quality Factor ETF (QUAL), iShares U.S. Utilities ETF (IDU), PowerShares Dynamic Food & Beverage Portfolio (PBJ), and iShares Global Healthcare ETF (IXJ). As in the previous analysis, the Other item in the chart collectively represents additional six ETFs with smaller weights, listed in the above table.

Finally, we will examine the Cambria Global Asset Allocation ETF (GAA). According to its issuer, the fund

…targets investing in approximately 29 ETFs that reflect the global universe of assets consisting of domestic and foreign stocks, bonds, real estate, commodities and currencies.

The following chart with accompanying statistics demonstrates the cumulative RealAlpha™ for the fund:

Cumulative RealAlpha™ for Cambria Global Asset Allocation ETF (GAA)

The fund moderately underperformed its reference ETF portfolio that had a slightly smaller standard deviation. The RealBeta™ of the fund was approximately the same as that of a traditional 60% stock / 40% bonds balanced portfolio.

The following chart and statistics show the composition of the reference ETF portfolio for the fund over the same period:

Reference Weights for Cambria Global Asset Allocation ETF (GAA)

The fund had major equivalent positions in the iShares MSCI Kokusai ETF (TOK), PowerShares DB Commodity Index Tracking Fund (DBC), FlexShares iBoxx 5-Year Target Duration TIPS Index Fund (TDTF), iShares U.S. Real Estate ETF (IYR), VanEck Vectors Emerging Markets High Yield Bond ETF (HYEM), and SPDR® Barclays Investment Grade Floating Rate ETF (FLRN). The remaining ETFs in the above table constitute the Other element in the chart.

It has to be noted that GMOM and GAA are relatively new products with only about 18 months of available history as of this writing. Typically, Alpholio™ uses at least 36 months of data for a more accurate analysis, which was the case with SYLD.

The second part of this series will review the Cambria Foreign Shareholder Yield ETF (FYLD) and the Cambria Global Value ETF (GVAL).

If you would like to use our ETP Analysis Service to examine similar products, please register on our website.


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Do iShares Smart Beta ETFs Outperform? (Part II)
analysis, exchange-traded fund, factor investing

In the first part of this post, we analyzed a couple of iShares smart beta ETFs, the iShares Edge MSCI USA Size Factor ETF (SIZE) and the iShares Edge MSCI USA Value Factor ETF (VLUE).

Let’s start the second part with the evaluation of the iShares Edge MSCI USA Momentum Factor ETF (MTUM). Its issuer states that this ETF generates

Exposure to large- and mid-cap U.S. stocks exhibiting relatively higher price momentum

As before, the analysis will start in the first full month of the ETF’s existence and end in July 2016. Here is the cumulative RealAlpha™ chart with related statistics for the ETF:

Cumulative RealAlpha™ for iShares Edge MSCI USA Momentum Factor ETF (MTUM)

The ETF produced a return comparable to that of its reference portfolio, which had a lower volatility. The RealBeta™ of the ETF was considerably below than that of a broad-based equity market ETF.

The following chart and associated statistics show the constant composition of the reference ETF portfolio for the iShares Edge MSCI USA Momentum Factor ETF:

Reference Weights for iShares Edge MSCI USA Momentum Factor ETF (MTUM)

The ETF had major equivalent positions in the Consumer Staples Select Sector SPDR® Fund (XLP), First Trust Large Cap Growth AlphaDEX® Fund (FTC), Health Care Select Sector SPDR® Fund (XLV), PowerShares Dynamic Large Cap Growth Portfolio (PWB), First Trust Dow Jones Internet Index Fund (FDN), and PowerShares NASDAQ Internet Portfolio (PNQI). (The Other component in the chart collectively represents additional two ETFs with smaller weights.)

Not surpringly, the ETF had a strong tilt toward large-cap growth stocks, especially in the consumer staples and healthcare sectors, as well as the Internet industry. Unlike with the previous iShares smart beta ETFs, no single position was clearly dominant in its reference portfolio. It can also be reasonably expected that in the future, the ETF’s exposure to specific sectors and industries will change along with price momentum shifts. Therefore, for a further performance comparison, a similar smart beta equivalent position should be chosen.

Over the same analysis period, MTUM outperformed FTC and PWB in terms of the annualized return and Sortino ratio, and had an equal or higher Sharpe ratio:

Total Return of iShares Edge MSCI USA Momentum Factor ETF (MTUM), First Trust Large Cap Growth AlphaDEX® Fund (FTC) and PowerShares Dynamic Large Cap Growth Portfolio (PWB)

At 0.15%, the expense ratio of MTUM was much lower than the 0.62% of FTC and 0.57% of PWB, which improved relative returns of MTUM. The average correlation between rolling 24-month returns was 0.95 and 0.96 for MTUM with FTC and MTUM with PWB, respectively.

Finally, we will evaluate the iShares Edge MSCI USA Quality Factor ETF (QUAL). According to the issuer, this ETF produces

Exposure to large- and mid-cap U.S. stocks exhibiting positive fundamentals (high return on equity, stable year-over-year earnings growth and low financial leverage)

Since QUAL’s inception date was in July 2013, the analysis begins in August 2013. Here is a chart with accompanying statistics of the cumulative RealAlpha™ for the ETF:

Cumulative RealAlpha™ for iShares Edge MSCI USA Quality Factor ETF (QUAL)

The ETF moderately outperformed its reference portfolio, which had a slightly higher volatility. The ETF’s RealBeta™ was lower than that of a broad-based equity market ETF.

The following chart with accompanying statistics depicts the composition of the reference portfolio for the iShares Edge MSCI USA Quality Factor ETF:

Reference Weights for iShares Edge MSCI USA Quality Factor ETF (QUAL)

The ETF had major equivalent positions in the iShares Russell Top 200 Growth ETF (IWY), SPDR® Dow Jones® Industrial Average ETF (DIA), PowerShares S&P 500 Quality Portfolio (SPHQ), Vanguard Dividend Appreciation ETF (VIG), PowerShares NASDAQ Internet Portfolio (PNQI), and iShares U.S. Energy ETF (IYE). Clearly, this ETF had a strong tilt toward mega-cap stocks, especially of the growth classification.

Over the same analysis period, QUAL had a significantly lower return as well as slightly smaller Sharpe and Sortino ratios than those of IWY:

Total Return of iShares Edge MSCI USA Quality Factor ETF (QUAL) and iShares Russell Top 200 Growth ETF (IWY)

The average correlation between rolling 24-month returns of the two ETFs was 0.98.

Conclusion

The above analyses uncovered reference portfolios for select iShares smart beta ETFs. While a wholesale substitution of an ETF with its multi-member reference portfolio may not always be practical, each of these portfolios

  • Built a foundation for assessment of the true risk-adjusted performance of a smart beta ETF.
  • Captured exposures of a smart beta ETF to various stock market styles, sectors and industries (paradoxically, these are exposures of the analyzed factor ETF to various other factors). This may help investors avoid an undesirable overlap with other positions in their overall investment portfolios.
  • Identified a predominant exposure of a smart beta ETF to a single factor. This may help investors substitute a smart beta ETF with another product that implements a traditional market-cap index or with a similar strategic beta strategy.

If you would like to use the ETP Analysis Service to examine other smart beta products, please register on our website.


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Do iShares Smart Beta ETFs Outperform? (Part I)
analysis, exchange-traded fund, factor investing

To better demonstrate the new Alpholio™ ETP Analysis Service in action, let’s analyze several of the iShares smart beta ETFs. The oldest of these products were introduced in mid-April 2013, so by now more than three years of performance data are available. According to their issuer

Smart beta ETFs can help investors achieve goals like reducing risk, generating income, or potentially enhancing returns. These funds primarily focus on factors – broad, persistent drivers of returns across equities and other asset classes. New technologies have made it easier to target factor exposures, which investors can access with iShares Edge ETFs.

Due to the scope of analysis, this post will be divided into two parts. We will start with the iShares Edge MSCI USA Size Factor ETF (SIZE). According to its issuer, this ETF provides

Exposure to large- and mid-cap U.S. stocks with a tilt towards the smaller, lower risk stocks within that universe

Here is a chart with related statistics of the cumulative RealAlpha™ for this ETF from May 2013 (the first full month of returns since its inception) through July 2016:

Cumulative RealAlpha™ for iShares Edge MSCI USA Size Factor ETF (SIZE)

The ETF returned effectively as much as its reference ETF portfolio that had a slightly lower volatility. The ETF’s RealBeta™, measured against a broad-based US equity index ETF, was close to one.

The following chart shows the constant composition of the reference ETF portfolio for the iShares Edge MSCI USA Size Factor ETF:

Reference Weights for iShares Edge MSCI USA Size Factor ETF (SIZE)

The ETF had equivalent positions in the SPDR Russell 3000® ETF (THRK), SPDR® Dow Jones® REIT ETF (RWR), SPDR® S&P® Insurance ETF (KIE), iShares U.S. Medical Devices ETF (IHI), IQ Hedge Multi-Strategy Tracker ETF (QAI), and Utilities Select Sector SPDR® Fund (XLU).

Over the same analysis period, SIZE outperformed THRK, the dominant position in its reference portfolio, in terms of a slightly larger annualized return, as well as higher Sharpe and Sortino ratios:

Total Return of iShares Edge MSCI USA Size Factor ETF (SIZE) and SPDR Russell 3000® ETF (THRK)

The average correlation between rolling 24-month returns of the two ETFs was 0.96.

The second smart beta ETF we will evaluate is the iShares Edge MSCI USA Value Factor ETF (VLUE). According to the issuer, this ETF supplies

Exposure to large- and mid-cap U.S. stocks with lower valuations based on fundamentals

Here is a chart with related statistics of the cumulative RealAlpha™ for this ETF:

Cumulative RealAlpha™ for iShares Edge MSCI USA Value Factor ETF (VLUE)

Since late 2014, the ETF failed to add value over its reference portfolio that had a slightly lower volatility. The ETF’s RealBeta™ was higher than that of a broad-based stock market ETF.

The following chart shows the fixed reference ETF portfolio for the iShares Edge MSCI USA Value Factor ETF:

Reference Weights for iShares Edge MSCI USA Value Factor ETF (VLUE)

The ETF had major equivalent positions in the SPDR® S&P® 500 Value ETF (SPYV), SPDR® Morgan Stanley Technology ETF (MTK), iShares U.S. Broker-Dealers & Securities Exchanges ETF (IAI), First Trust Large Cap Value AlphaDEX® Fund (FTA), iShares U.S. Healthcare Providers ETF (IHF), and iShares Transportation Average ETF (IYT). The Other component in the chart collectively represents two additional ETFs with smaller weights.

Although VLUE had a slightly higher annualized return than SPYV (the prevailing ETF in its reference portfolio), it underperformed SPYV in terms of both Sharpe and Sortino ratios:

Total Return of iShares Edge MSCI USA Value Factor ETF (VLUE) and SPDR® S&P® 500 Value ETF (SPYV)

The average correlation between rolling 24-month returns of the two ETFs was 0.98.

The second part of this post will cover two other iShares smart beta ETFs, the iShares Edge MSCI USA Momentum Factor ETF (MTUM) and iShares Edge MSCI USA Quality Factor ETF (QUAL).


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Introducing ETP Analysis Service
active management, analysis, exchange-traded fund, exchange-traded product, portfolio

Alpholio™ has recently added the ETP Analysis Service to its platform. The exchange-traded product (ETP) is an exchange-traded fund (ETF), exchange-traded note (ETN), NextShares ETMF®, or other exchange-traded financial instrument.

The main motivation behind the new service is the availability of ETPs that do not track market-cap weighted indices. In particular, this includes “smart beta” (a.k.a. “strategic beta“) strategies that blend active and passive management. Due to the former aspect, smart-beta ETPs resemble traditional actively-managed mutual funds. Consequently, they can be analyzed with Alpholio™’s patented methodology, which constructs a custom reference portfolio of ETFs for each analyzed fund.

This leads to an apparent paradox: an analyzed ETP (which may be an ETF) is to be replicated by a portfolio of ETFs. Why do this at all? Just as with a traditional mutual fund, for several main reasons:

  • To determine whether active management aspect of the ETP adds value on a truly risk-adjusted basis
  • To understand the exposure of the analyzed ETP to various factors. This helps eliminate excessive exposures in the overall investment portfolio.
  • To replicate the ETP’s performance with other ETFs that may have preferable characteristics, such as lower fees, smaller trading premia or spreads, accessibility, etc. Conversely, to simplify a portfolio by substituting multiple ETFs with a single ETP.
  • To discern periods of underperformance and outperformance of the ETP after adjustment for its exposures.

Let’s demonstrate the new ETP Analysis Service in action. First, we will analyze the PowerShares FTSE RAFI US 1000 Portfolio (PRF). This ETP tracks the FTSE RAFI US 1000 Index, which

…is designed to track the performance of the largest US equities, selected based on the following four fundamental measures of firm size: book value, cash flow, sales and dividends. The 1,000 equities with the highest fundamental strength are weighted by their fundamental scores.

To conduct the analysis, we will use the simplest variant of Alpholio™’s methodology, which builds a reference ETF portfolio with both fixed membership and weights. The following chart and related statistics show the cumulative RealAlpha™ for the ETP (to learn more about this and other performance measures, please visit our FAQ):

Cumulative RealAlpha™ for PowerShares FTSE RAFI US 1000 Portfolio (PRF)

Over the five years through July 2016, the ETP added a small amount of value vs. its reference ETF portfolio of comparable volatility. The RealBeta™ of the ETF was the same as that of a broad-based equity market ETF.

The following chart with accompanying statistics presents the fixed composition of the reference ETF portfolio for the analyzed ETP:

Reference Weights for PowerShares FTSE RAFI US 1000 Portfolio (PRF)

The ETP had major equivalent positions in the iShares Russell 1000 Value ETF (IWD), Vanguard Value ETF (VTV), iShares Core S&P Total U.S. Stock Market ETF (ITOT), SPDR® S&P® 500 Value ETF (SPYV), PowerShares BuyBack Achievers Portfolio (PKW), and Guggenheim S&P 500® Pure Value ETF (RPV). Clearly, this ETP had a very strong exposure to the large-cap value factors represented by reference ETFs. (The Other component in the chart collectively depicts additional six ETFs with smaller weights, some of which were effectively zero.)

In the second example, let’s analyze the Guggenheim S&P 500® Equal Weight ETF (RSP). This ETP

Seeks to replicate as closely as possible the performance of the S&P 500 Equal Weight Index, before fees and expenses, on a daily basis.

Here is the chart with related statistics of the cumulative RealAlpha™ for this ETP:

Cumulative RealAlpha™ for Guggenheim S&P 500® Equal Weight ETF (RSP)

Over the five years through July 2016, this ETP also added little value vs. its reference ETF portfolio. Its RealBeta™ was above that of a broad-based stock market ETF.

The final chart and statistics show the static composition of the reference ETF portfolio for the ETP:

Reference Weights for Guggenheim S&P 500® Equal Weight ETF (RSP)

The ETP had major equivalent positions in the First Trust Large Cap Core AlphaDEX® Fund (FEX), iShares Russell Mid-Cap Value ETF (IWS), PowerShares S&P 500 Quality Portfolio (SPHQ), PowerShares S&P 500® High Beta Portfolio (SPHB), iShares Russell Mid-Cap Growth ETF (IWP), and Consumer Discretionary Select Sector SPDR® Fund (XLY). The Other component in the chart collectively represents additional six ETFs with smaller constant weights, one of which was effectively zero.

As could be expected, due to equal-weighting of its positions this large-cap ETP had a significant tilt toward mid-cap stocks, especially of value characteristics. In addition, the ETP had considerable exposure to economic sectors such as consumer discretionary, financials, technology, and industrials.

If you would like to take advantage of the new ETP Analysis Service, please register on our website.


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A Case for Mid-Cap Stocks
analysis, asset allocation, exchange-traded fund, portfolio

In a traditional portfolio, mid-cap and small-cap equities receive much smaller weights than large-caps. For example, the most recent moderate asset allocation model portfolio recommended by the S&P Capital IQ Investment Policy Committee (see in the November 24, 2014 edition of the S&P The Outlook), consists of the following allocations:

  • 50% to U.S. equities
  • 15% to foreign equities
  • 25% to bonds
  • 10% to cash

To achieve the model allocation, the committee recommends specific ETFs for the 50% U.S. equity part of the portfolio:

Therefore, the mid-cap and small-cap stocks collectively account for only 20% of domestic equities in the portfolio. Is such a low allocation justified by historical performance of these asset classes? Let’s take a look using the Portfolio Service of the Alpholio™ App for Android.

The longest analysis time frame is determined by the existence of IJR, whose first full monthly return was in June 2000 (SPY’s first monthly return was in February 1993, and MDY’s in June 1995). Here are the statistics of a portfolio solely composed of SPY in a period from that month through 2014:

SPY Performance from 2000 to 2014

Similarly, for MDY:

MDY Performance from 2000 to 2014

And for IJR:

IJR Performance from 2000 to 2014

The mid-cap (MDY) and small-cap (IJR) ETFs had annualized returns more than twice that of the large-cap ETF (SPY). The Sharpe ratios of MDY and IJR were also approximately twice that of SPY. While IJR outperformed MDY in terms of the annualized return, alpha and Sharpe ratio (just slightly), it also had the highest standard deviation (volatility), maximum drawdown and beta of all three ETFs. Therefore, the mid-cap ETF appears to be a decent compromise between risk and reward.

For the 10-year period through 2014, the statistics are as follows:

ETF Annualized Return Standard Deviation Alpha* Beta* Sharpe Ratio Max. Drawdown
SPY 7.61% 14.66% -0.02% 0.96 0.48 50.8%
MDY 9.42% 17.66% 0.05% 1.12 0.52 49.7%
IJR 8.96% 18.91% -0.01% 1.16 0.48 51.8%

* In this analysis period, alpha and beta are measured against a broader market index, represented by the Vanguard Total Stock Market ETF (VTI).

In the evaluation period, MDY clearly outperformed its peers by generating the highest annualized return, alpha and Sharpe ratio, while having the lowest maximum drawdown.

Another service offered by the Alpholio™ App for Android is the Rolling Returns analysis. In the 10-year period through 2014, SPY returned more than VTI in about 9.4% of all rolling 36-month periods (a rolling period of 36 months aims to approximate the average holding time of the ETF in an investment portfolio):

SPY vs. VTI Rolling Returns from 2005 to 2014

However, in the same period, MDY outperformed VTI in about 75.3% and IJR in 70.6% of all rolling 36-month periods. Based on this simple measure (it does not take risk into account), MDY again demonstrated a superior performance.

While past performance is not a guarantee of future results, this analysis indicates that mid-cap equities may deserve a higher allocation even in a moderate-risk portfolio. A follow-on post will examine the characteristics of growth vs. value equities, also using services of the Alpholio™ App for Android. The app is available at:

Get It on Google Play


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Entering an Exclusive Dimension
analysis, factor investing, mutual fund, value investing

A cover story in Barron’s provides lots of interesting details about the history and operations of Dimensional Fund Advisors (DFA). Founded in 1981, DFA has recently reached $332 billion in assets under management (AUM).

DFA's Three Decades of Growth

About 78% of these AUM are in stocks, and about 85% in low-cost mutual funds with an average expense ratio of 0.39%. The funds have a small-cap and value tilt, based on the Fama-French three-factor model. Lately, the firm started to augment its funds with a profitability factor.

The article states that

More than 75% of its funds have beaten their category benchmarks over the past 15 years, and 80% over five years, according to Morningstar — remarkable for what some investors wrongly dismiss as index investing.

To substantiate this, the article compares two similar funds from DFA and Vanguard:

For example, take the Vanguard Small Cap Value index fund (VISVX), which is based on the S&P 600 Small Cap Value index and is the counterpart to Dimensional’s DFA US Small Cap Value (DFSVX). The DFA fund has a much smaller tilt — its average market value is $1.1 billion, versus Vanguard’s $2.7 billion — and on all measures is much more value-oriented. So the Dimensional fund better captures the market-beating advantage of small and value stocks. In fact, a lot better: The DFA fund returned 42% in 2013, beating 88% of its peers in Morningstar’s small-cap value category, versus the Vanguard fund’s 36% return, which beat just 53%. Over 15 years, which includes periods that were less favorable to small and/or value stocks, DFA’s fund returned an average of 12% a year, beating 80% of peers. The Vanguard fund returned 10% on average, beating just 37% of peers. The Dimensional fund costs twice as much as Vanguard’s — 0.52% versus 0.24% — but the significant outperformance more than makes up for that difference.

That only tells a part of the story. According to Morningstar data, DFSVX had a lower Sharpe Ratio than VISVX in the 3-year (0.96 vs. 1.01) and 10-year (0.47 vs. 0.48) periods through 2013. This is also reflected in the generally higher volatility and upside and downside capture ratios for the DFA fund. As a result, the DFA fund produced lower returns than the Vanguard fund did in the down years of 2007, 2008 and 2011.

The article says that a deliberately paced trading as well as market making in the 14,000 stocks DFA owns both add to its outperformance. However, DFA faces an ongoing criticism: since its funds are sold exclusively through 1,900 rigorously screened and trained financial advisors, they are not easily accessible to individual investors, especially those with a small amount of investable assets, not willing to pay advisory fees or already having an unaffiliated advisor. This is what creates an “exclusive dimension” of DFA, which Alpholio™ can help investors enter. Following up on one of the previous posts, let’s analyze DFSVX in more detail.

The following chart shows the relative performance of the fund vs. its reference portfolio of ETFs:

Cumulative RealAlpha™ for DFSVX

An investor who committed to the fund in early 2005 would have gained only a modest amount of cumulative RealAlpha™ by late 2013. This was mostly caused by the fund’s underperformance in the three years mentioned above. In addition, at about 22.7% the annualized volatility of the fund was 2% higher than that of its reference portfolio in the overall analysis period.

The next chart illustrates ETF weights in the reference portfolio in the same period:

Reference Weights for DFSVX

The fund could effectively be emulated by a collection of just four related ETFs: iShares Russell 2000 Value (IWN; average weight of 34.9%), iShares S&P Small-Cap 600 Value (IJS; 30.1%), iShares Morningstar Small-Cap (JKJ; 18.5%), and iShares Morningstar Small-Cap Value (JKL; 13.7%). (The remaining two ETFs accounted for only 2.8% of the reference portfolio on average.)

The weighted expense ratio of these four ETFs is currently only 0.33% compared to the fund’s 0.52%. In addition, while an investor trading these ETFs might incur some commission, spread and premium/discount costs, he/she would not have to pay a recurring advisory fee of about 1% (or be forced to switch advisors) to gain benefits similar to those offered by DFA funds. Over time, dedicated factor ETFs will likely make such fund substitution even easier. Thus, entering an exclusive dimension of factor investing is no longer as hard as it has been.

To get a unique perspective on the DFA and other funds, please register on our website.


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Exchange-Traded Product Statistics
exchange-traded fund, exchange-traded product

A paper from PwC provides interesting statistics on exchange-traded funds (ETFs) and products (ETPs). [Alpholio™ uses the latter term to encompass ETFs, exchange-traded notes (ETNs), and other similar investment vehicles.]

As of 3Q2013, about $2.2T was invested in almost 5,000 ETPs globally:

PwC Global ETF and ETP Totals

Thanks to a large single market, an average ETP had much more AUM in the US than elsewhere (however, this does not take into account the typical right skew of the AUM distribution, whereby a small number of funds hold the majority of assets):

PwC Global ETF and ETP per Region

Unlike elsewhere, in the US the majority of ETP AUM belong to retail investors:

PwC ETF Use by Region

The percentage of AUM in active ETFs, whose launch began only in 2008, is still small but growing:

PwC Assets in Active vs. Index ETFs

PwC Active ETF Launches

ETFs enable the shift from individual security selection to asset allocation, especially in liquid markets:

PwC ETFs Displacing Mutual Funds in US Equity Category

ETFs now cover a broad spectrum of asset classes:

PwC ETF Asset Class Coverage

All these findings strongly support the Alpholio™ thesis: the growing number, breadth and variety of ETPs enable more and more accurate assessment and substitution of actively-managed mutual funds and arbitrary investment portfolios for the benefit of investors.

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Sector ETFs from Fidelity
exchange-traded fund

Fidelity Investments is about to introduce a set of ten sector ETFs that will compete with similar products from State Street (Select Sector SPDR), BlackRock (iShares) and Vanguard (sector-specific ETFs).

NYSE - Upcoming Fidelity Sector ETFs

The new ETFs will undoubtedly complement the current offering of 65 iShares ETFs that can be traded commission-free in Fidelity accounts if held for more than 30 days. The expense ratio of these ETFs will be 0.12%, lower than the average of 0.18% for SPDRs, 0.45% for iShares and 0.14% for most of Vanguard ETFs.

However, in addition to reported expense ratios, investors should also take into account trading costs, including bid/ask spreads and premium/discount to the net asset value (NAV) of each ETFs. With the highest trading volumes, SPDR ETFs are leaders in that respect.

The following table summarizes the existing U.S. sector ETFs from major issuers:

Sector SPDR iShares Vanguard
Consumer Discretionary XLY IYC VCR
Consumer Staples XLP IYK VDC
Energy XLE IYE VDE
Financials XLF IYF VFH
Health Care XLV IYH VHT
Industrials XLI IYJ VIS
Information Technology XLK IYW VGT
Materials XLB IYM VAW
Telecommunication Services XTL* IYZ VOX
Utilities XLU IDU VPU

*The SPDR® S&P® Telecom ETF (XTL) is not part of the original Sector SPDRs; its expense ratio is 0.35%.
The new Fidelity sector ETFs will track MSCI IMI sector indices. In contrast, the nine SPDR ETFs track S&P sector indices that collectively represent all stocks in the S&P 500® index. iShares ETFs track the Dow Jones U.S. sector indices. As of February 2013, Vanguard ETFs track MSCI 25/50 indices that cap each fund’s exposure to stocks dominant in a given sector.

From Alpholio™’s perspective, these sector ETFs should benefit investors by expanding the pool of securities that can be used to build substitution portfolios for actively-managed mutual funds in a cost-effective manner (low expense ratio, commission-free trading).

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