AlphaMark Advisors is the latest fund manager to turn to the exchange traded fund space, launching an actively managed small-cap ETF that was converted from a mutual fund.
The recently launched AlphaMark Actively Managed Small Cap ETF (SMCP) , which has $23.7 million in assets under management, fills a hole in the AlphaMark fund line up after the firm terminated the AlphaMark Small Cap Growth Fund (AMSCX) back in April, according to a Securities and Exchange Commission filing. AMSCX, which was launched in November 2008, outperformed the Russell 2000, net of fees, by 2.5%. The fund provider, though, still manages the AlphaMark Large Cap Growth Fund (AMLCX).
SMCP is only one of two actively managed small-cap ETFs in the space. The AlphaMark ETF is competing with the iShares Enhanced U.S. Small-Cap ETF (IESM) in the active small-cap ETF segment.
Tom Lydon, publisher of ETF Trends, recently had a chance to talk with Michael L. Simon, President and Chief Investment Officer of the Adviser, who will handle the day-to-day management of the fund.
The active small-cap ETF typically focuses on companies with a market-cap of between $150 million and $2 billion. While the main focus of the ETF is U.S. small-caps, SMCP can also hold up to 30% of net assets in foreign small-cap equity securities traded on a U.S. exchange as ADRs.
Simon also told ETF Trends that the small-cap growth strategy implements a number of factors when selecting component holdings. Once SMCP has grabbed alpha, the strategy may revert back to the Russell 2000. If the portfolio outperforms the benchmark index by 5%, the portfolio will go back to its starting universe of Russell 2000 stocks, Simon added. Then a phantom portfolio will be created from the ETF’s positions and managed the same way as a live portfolio, including buys and sells. Because SMCP is a concentrated fund with high beta stocks, invariably the phantom portfolio’s outperformance will revert to the mean. At this point the Russell 2000 Index inside of SMCP will be sold and the phantom portfolio will be bought back into SMCP thereby creating another alpha-generating opportunity.
The manager will utilize an internal screening process that identifies companies with reliable cash flow streams and are priced at a level that provides growth opportunity. The initial screen will whittle down the universe of small-cap growth to about 150 stocks and then implement further screens, including market return on equity, sufficiency of cash flow to cover capital spending, operating margin relative to price-to-sales, financial statement review with a focus on true equity value, and enterprise value review and management review, which include factors like insider trading, stock option distributions and share buybacks.
For instance, the methodology has targeted companies with a three-year revenue growth of 14%, earnings growth of 16% and a return on equity greater than 15%, Simon said.
In the end, the active ETF will hold about 25 and 40 stocks after all the screens. According to AlphaMark, there are currently 29 components, and the top positions include Basic Energy (BAS), BOFI Holdings (BOFI) and Dycom Industries (DY) 4.8%.
Simon also explained that component weightings could follow a more equal-weight methodology over time as the fund trims gains from holdings that have grown. Additionally, SMCP may favor sectors that have shown higher momentum – there is no utilities sector exposure at this time.
“Current allocations are still above the Russell 2000 weights,” Simons told ETF Trends. “The ETF is a little overweight in energy as we can’t avoid the attractive valuations.”
On the sell side, Simon outlines a disciplined approach to trimming positions. A component may be ditched if there is a significant change in a company’s structure or management, a change in the industry or sector due to outside factors like legislation, a position exceeds 7% of the portfolio or doubled, a stock experiences a decrease in earnings momentum by more than 5%, or a stock price is overvalued 20% or more based on cash flow models.
SMCP has a 0.90% expense ratio.
For more information on active ETFs, visit our actively managed ETFs category.
Max Chen contributed to this article.