This article was originally published on ETFTrends.com.
When it comes to valuations, or a measure of stock prices in relation to underlying companies’ worth, like earnings or revenue, stocks are now trading near historically high valuations.
Valuations are particularly worrisome for passive investors whom largely rely on traditional, market capitalization-weighted index funds, which mirror an index and weight components by each company’s market capitalization. As the markets strengthen and break new highs, investors in market-cap funds will have greater exposure to company stocks that have increased in price the most, which leaves many exposed to sudden bouts of devaluation.
Specifically, the recent bull market record run up has been driven by technology stocks, and tech names make up a hefty tilt in the S&P 500, with major components like Apple (AAPL) , Microsoft (MSFT) , Amazon.com (AMZN) and others among the top holdings.
As investors seek out new ways to diversify their portfolio risks, many may look to value-oriented strategies, such as one that weights securities by companies’ revenue in an attempt to avoid the risk of overpriced stocks.
Investors who believe in a return to fundamentals can look to the revenue-weighted methodology, including options like the Oppenheimer Large Cap Revenue ETF (NYSEArca: RWL) , Oppenheimer Mid Cap Revenue ETF (NYSEArca: RWK) and Oppenheimer Small Cap Revenue ETF (NYSEArca: RWJ) .
The underlying index implements a rules-based, disciplined smart beta indexing methodology targets known indices like the S&P 500 and tries to improve their performance return through weighting each security in the index by top line revenue. Components are then rebalanced every quarter to keep the Revenue-Weighted indices in line with the companies’ most recently reported revenue levels.
Revenue weighting could provide diversified exposure to the market, is not influenced by stock price, reflects a truer indication of a company’s value and offers stable sector exposure. Moreover, revenue weighting may provide a more value-oriented portfolio and historically outperformed in a value-driven market while showing lower drawdowns during growth-driven markets.
By rebalancing toward companies with persistent sales, revenue weighting helps keep a portfolio from overstaying during an overheating market. The result could be a portfolio with better risk-adjusted returns over the long haul.
For more on smart beta ETFs, visit our Smart Beta Channel.
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