They provide a low-cost, convenient and transparent way of replicating market/segment returns.
But many investors have realized that capitalization weighted indexes are not the most efficient way of investing, at times.
The Problem with Market-Cap Weighted Indexes
Market capitalization weighted indexes give higher weights to bigger and often over-priced companies. Further as a stock rises in value, its weight in the index increases and when it falls, its weight in the index also comes down—somewhat similar to buying high and selling low—making these strategies inefficient. (Read: 3 Niche ETFs that will keep flying higher)
Thus sensible non market-cap weighted strategies add value over capitalization weighted indexes over time. In fact, research show that even random weighting strategies like–monkey throwing darts–consistently outperform cap-weighted indexes.
Weighting on measures like revenue, earnings, cash flow, dividends have beaten the market cap weighting strategies according to numerous studies.
Why Should You Focus on Revenue?
Many analysts believe that revenues and not earnings are a better indicator of a company’s financial health as earnings are easier to “manage”. Due to Wall Street’s focus on earnings, many companies use accounting tricks to flatter earnings.
Top-line growth is transparent and difficult to manipulate and thus in my opinion one of the most effective fundamental factors for weighting the index holdings.
Revenue Weighted ETFs
RevenueShares pioneered revenue-weighted ETFs and currently sponsors seven such ETFs. Six of these ETFs indexes track the same securities as their benchmark S&P indexes, but in different weights–based on their revenue–instead of market capitalization. Thus at the time of quarterly rebalancing they are comprised of fewer higher priced stocks (based on price to revenue ratio) and more lower priced stocks.
In this article, we have highlighted three revenue-weighted ETFs tracking large cap, mid cap and small cap segments of the market. These products made their debut in February 2008.
|Index||Market Cap Weighted ETF||5 Year Return||Revenue Weighted ETF||5 Year Return|
|S&P MidCap 400||MDY||219.8%||RWK||255.2%|
|S&P SmallCap 600||SLY||260.2%||RWJ||318.6%|
RevenueShares Large Cap Fund (NYSEARCA:RWL)
RWL is comprised of the same securities as the S&P 500 index but the holdings are ranked by top-line revenue instead of market capitalization.
Wal-Mart, Exxon Mobil, Chevron and Berkshire are the top holdings as of now. Consumer Discretionary, Consumer Staples. Energy and Financials occupy the top spots in terms of sector exposure.
The product charges an expense ratio of 49 basis points. It is a Zacks ETF Rank # 2 (Buy) ETF.
RevenueShares Mid Cap Fund (NYSEARCA:RWK)
RWK holds same securities as the S&P MidCap 400 index, weighting the holdings by top-line revenue instead of market-capitalization.
Ingram Micro, World Fuel Services and Tech Data are the top holdings at present. Consumers, Industrials and Financials are the top sectors.
The product charges an expense ratio of 54 basis points. It is a Zacks ETF Rank # 3 (Hold) ETF.
RevenueShares Small Cap Fund (NYSEARCA:RWJ)
RWJ is comprised of the same securities as the S&P SmallCap 600 index but the holdings are ranked by top-line revenue instead of market capitalization.
Centene Corp, Synnex Corp and Barnes & Noble are the top holdings as of now but the fund is very well diversified with top 10 holdings accounting for just 13.5% of total assets. Consumers, Industrials and Technology are the top sectors.
The product charges an expense ratio of 54 basis points. It is a Zacks ETF Rank # 2 (Buy) ETF.
This article is brought to you courtesy of Eric Dutram.