Fundamental vs. Market Cap weighted Indexing

Mona

In my taxable account, one of my positions is VTSAX, a market cap weighted total stock market index fund. I am looking for more exposure to large caps and came across SFLNX, which intrigued me because while an index fund, it is a Fundamental index fund, instead of market cap weighted.

SFLNX carries a bit more large caps than VTSAX as well as leans toward value, due to the nature of Fundamental indexing, and re-balancing. I like VTSAX because of its lower ER (0.05% vs. 0.32%) and lower tax cost ratio, but at current market levels SFLNX looks interesting because of its value bias with more undervalued stocks.

I would appreciate your thoughts regarding SFLNX, a large cap Fundamental index fund, compared to VTSAX, a market weighted index fund.

Mona

Ted

Dear Mona: For your information here are the two funds side-by-side. I like the Schwab Fund over Vanguard
Regards,
Ted
Lipper Snapshot Of SFLNX: http://www.marketwatch.com/investing/fund/sflnx
Lipper Snapshot Of VTSAX: http://www.marketwatch.com/investing/fund/vtsax

Mona

Reply to @Ted:

Hi Ted,

Thanks for your thoughts.

I was rather surprised to see the lowest Lipper rating of 1, in the area of tax efficiency. This raises another thought. Possibly I should be looking in the direction of a Large Cap Value fund with a low turnover, low ER, and better tax efficiency. VEIPX, VUVLX, and VIVAX certainly seem to meet the critera.

Mona

slick

Mona,

I know you wanted more large cap, but another option might be RSP, which is the Guggenheim Equal Weight S + P 500 ETF. Its a different approach. I have RHS, the equal weighted Consumer Staples ETF which I bought at the same time as XLP, and it is handily beating the market weighted index. I could not decide which one I liked better, so bought both. They do have different holdings however. Just a thought. The ER is a bit higher, but so are returns

kevindow

Hi Mona,

Here is a recent article which discusses market cap-weighted, equal-weighted and fundamental index funds, and a linked WSJ article as well:

http://finance.yahoo.com/news/investors-consider-outperforming-smart-beta-183306723.html

I am partial to the fundamental index funds, such as the very similar PRF and SFLNX.

Kevin

STB65

While the fundamental index funds and equal weight index funds concept have always seemed sensible, they seem to be lagging in YTD performance by 3 to 7 percent in this aberrant year.
I googled Martin ratio with fundamental index, getting zilch. If one is anxious about this market (and I am, since I seem to be making paper profits), is there data on the FI or EW fund response in a significant decline?

kevindow

Reply to @STB65:

So far this year, RSP (equal weight index) is up 22.79% and PRF/SFLNX (fundamental indices) are up 23.49%/22.63%, while SPY is up 20.18% (all market prices). Furthermore, RSP, PRF and SFLNX have outperformed SPY over the past 1-, 3- and 5-year periods. And RSP has outperformed SPY over the past 10-years. However, RSP, PRF and SFLNX have all had higher standard deviations over all periods.

Kevin

Kenster1_GlobalValue

Some additional Fundamental or Factor-weighted ETF choices:

SIZE - iShares MSCI US Size Factor ETF - New iShares ETF that takes the MSCI US Index and weights stock with an emphasis towards lower than market-cap weighting plus lower volatility. Holds around 600 stocks and has a low ER of 0.15%

Top 10 holdings of SIZE:

PEPSICO INC 0.68%
SOUTHERN CO/THE 0.66%
WISCONSIN ENERGY CORP 0.60%
JOHNSON & JOHNSON 0.60%
CONSOLIDATED EDISON INC 0.59%
KIMBERLY-CLARK CORP 0.59%
GENERAL MILLS INC 0.57%
DUKE ENERGY CORP 0.56%
XCEL ENERGY INC 0.55%
DOMINION RESOURCES INC/VA 0.55%


TILT - FlexShares M* US Market Factors Tilt - diversified like an index holding 2,500 stocks but tilted towards Small & Value. If you look at the M* portfolio breakdown you can definitely see a more even distribution across large, mid, small and microcaps than in a marketcap-weighted index.


VLUE - iShares MSCI USA Value Factor ETF - targets mid to large-caps with a greater value factor emphasis.

Charles

Mr. Arnott has taken some heat lately on the board, along with other fund managers that have been avoiding US equity markets. But RAFI appears to have legs. Here's link to short summary in David's May commentary, scroll down to "Three Messages from Rob Arnott." The first message is about Fundamental Indexation.

Kenster1_GlobalValue

Additional info on the SIZE etf by iShares I mentioned above --- the lower risk model they use is based on weightings of each stock and on the inverse of its historical variance based on 3 years of weekly data. So essentially this is a market index with negative exposure to 2 systematic factors - size & volatility. And so the top 10 holdings I listed above gives you a glimpse of things.

It also looks like Low/Min Volatility Factor ETFs have been quite popular since their relatively recent debut:

Assets:

SPLV: $4.7B
USMV: $3.1B
EEMV: $2.3B
ACWV: $1B

Arnott's Fundamental Indexes (e.g. PRF = $2.2B in assets) is interesting as well as you guys alluded to. It'll maintain it's value-tilt because of the way it weights the stocks based on economic footprint versus direct influence from stock price which can runaway and greatly affect market-cap. Which is why after its rebalancing last year --- you found deep-value stocks like Citibank and Bank of America higher on the list than Apple. I believe it does its rebalancing/reconstitution annually.

Mona

Reply to @STB65:

From the limited research I know how to do, it appears Fundamental Indexing does nicely with US large-cap stocks.

I find less evidence with small or mid cap stocks.

Mona

golub1

I've been looking for a fundamentally weighted emerging market ETF. Any suggestions?

Charles

Reply to @golub1: A quick look finds PXH, but its numbers don't look so good compared to some alternatives in Diversified EM offerings:

golub1

Reply to @Charles: Thanks I'll check it out. I read in Morningstar that they don't think the ETF's or as suitable for EM as are individual funds. I own Seafarer, and maybe that is as good as it gets.

AndyJ

Reply to @golub1: Pimco has PEFIX, apparently a total return version of the RAFI EM approach; not the simplest strategy in the world, and I haven't researched it in any depth.

Unless you're specifically after a RAFI product, "fundamentally weighted" can cover different sorts of territory depending on the definition; I assume you know about DEM and DGS at WisdomTree, which are dividend weighted, and the low-vol option EEMV.

Kenster1_GlobalValue

Another one is TLTE - (Northern Trust) Flexshares M* Emerging Markets Factor Tilt ETF

Very diversified with about 1,900 stocks. It takes the EM Index and gives a 2-factor weighting emphasis to Small and Value. You can see from the M* allocation that the large, mid and small allocation is much more evenly distributed versus the mega-largecap top heavy EM index.

So could be interesting option as a core EM holding to give a nice more evenly distributed marketcap allocation and without worry about the fund getting too growthy on you.

http://flexshares.com/exchange-traded-funds/morningstar-emerging-markets-factor-tilt-index

DEM and DGS are good but wow they can have big allocation changes. DEM used to have very little in Russian stocks but now it's at the top of the heap with 19% allocation. So if you don't mind the huge country swings then DEM could be a possibility - but maybe used as a diversifier rather than a core as it may be hard for some investors to handle. But the payoff could be good in the long-term as it has reweighted itself to juicy yielding stocks which happens to be a lot of Russian and China stocks that have taken a nosedive in their stock prices.

BenWP

SIZE is an interesting ETF in concept. Hard to get a handle on a fund, however, that didn't trade after 11:00AM on Monday, July 22nd. Maybe size does matter.