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A Closer Look at Fundamental Index ETFs


Fundamental index exchange traded fund methodologies can provide an alternative way to access the market, but potential investors should familiarize themselves with how the investment vehicle works.

The new breed of fundamental, or “smart-beta,” ETFs track indices that are constructed based on factors like strong balance sheets, steady earnings growth or dividend growth. In comparison, traditional beta index ETFs follow a market-capitalization methodology.

Due to the way stocks are selected, fundamental ETFs act like value investments, writes Brendan Conway for Barron’s.

Consequently, Conway warns that value investing is not always easy. Many investors may have to wait years before the right conditions line up. [How ‘Smart-Beta’ ETFs Fit in a Portfolio]

“You have to be in these strategies for the long haul,” Rick Ferri, founder of Troy Portfolio Solutions, said in the article.

For instance, the PowerShares FTSE RAFI US 1000 Portfolio (PRF) has shown periods of slightly mirroring the S&P 500′s performance. Over the past three years’ annualized returns, PRF gained 17.3% compared to the S&P’s 16.9%. Over a longer period of five years, PRF has outperformed, rising an annualized 10.2%, compared to the S&P’s annualized 7.2%.

“Given its small-cap and value tilts, PRF will likely underperform during market downturns and outperform during bull markets,” according to Morningstar analyst Alex Bryan. “It can also offer some protection against growth-oriented market bubbles.”

Investors can find enhanced index-based ETFs from Charles Schwab, First Trust, Guggenheim, PowerShares, RevenueShares and WisdomTree. Additionally, there are a number of dividend-oriented index ETFs provided by industry leaders like iShares, State Street and Vanguard. [Jaffe Weighs in on Schwab Fundamental ETFs]

For more information on fundamental methodologies, visit our indexing category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Mr. Lydon serves as an independent trustee of certain mutual funds and ETFs that are managed by Guggenheim Investments; however, any opinions or forecasts expressed herein are solely those of Mr. Lydon and not those of Guggenheim Funds, Guggenheim Investments, Guggenheim Specialized Products, LLC or any of their affiliates. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.