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A Structural Analysis of the Smart Beta Fund FEX

Ivan Kading

A Structural Analysis of Smart Beta Fund FEX

Multifactor model

The First Trust Large Cap Core AlphaDEX ETF (FEX) is based on the Defined Large Cap Core Index. The index provider selects stocks on the basis of alpha. In simple terms, alpha is the additional return generated over a specified benchmark.

The index provider uses a specially designed AlphaDEX selection methodology, which objectively identifies and selects stocks from the S&P 500 Index. The selected stocks may generate a positive alpha relative to traditional passive-style indexes. The FEX underlying index takes a more fundamental approach toward stock selection.

FEX in comparison with other ETFs

The above graph compares the performance of FEX with other fundamentally active ETFs such as the iShares MSCI USA Quality Factor ETF (QUAL) and the FlexShares Quality Dividend Index ETF (QDF). QUAL’s stock selection methodology is based on a multifactor model determined by high return on equity, stable year-over-year earnings growth, and low debt to equity of shares.

QDF’s stock selection method is also based on a similar fundamentally based model. FEX and QDF had underperformed in the market whereas QUAL had a significant decisive run in the market, although it was the most volatile among them.

Alpha based

The top five holdings of FEX are Amazon (AMZN), First Solar (FSLR), Murphy Oil Corp. (MUR), NVIDIA Corp. (NVDA), and Applied Materials (AMAT). Stocks with high alpha are mostly fundamentally strong, giving consistent returns to their investors. Alpha is an indication of how much an investment outperforms or underperforms on a risk-adjusted basis relative to its benchmark.

In the next part of this series, we will analyze the market performance of FEX with respect to the broader market indexes.

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