Investors can diversify their core equity positions with smart-beta exchange traded funds that have outperformed traditional market capitalization-weighted indices and provide an alternative indexing methodology.
For instance, the PowerShares FTSE RAFI US 1000 Portfolio (NYSEArca: PRF), which tracks the FTSE RAFI US 1000 Index, is up 8.2% year-to-date and has returned an average 20.7% over the past five-years. [Alternatively Weighted ETFs Keep Gaining Supporters]
In comparison, the Russell 1000 Index, which tracks 1,000 of the largest U.S. securities based on market cap, has gained 7.3% year-to-date and returned an average 19.3% over the past five-years.
“Market-cap-weighted indexes tend to overweight expensive stocks and underweight cheaper ones,” according to Morningstar analyst Alex Bryan. “PowerShares FTSE RAFI US 1000 PRF seeks to address this potential problem while retaining the benefits of a traditional index fund. It weights its holdings according to fundamental measures of size, including book value, cash flow, sales, and dividends, rather than market cap.”
Due tp PRF’s indexing methodology, the ETF tends to skew toward value stocks. Looking at the fund’s market capitalization and style allocations, large-cap value makes up 38.0% of PRF, followed by large-cap blend 26.3%, large-cap growth 12.8%, mid-cap value 9.6%, mid-cap blend 6.1% and mid-cap growth 2.6%.
“Unlike traditional value index funds, this fund does not restrict its holdings to one segment of the Morningstar Style Box, which may improve diversification,” Bryan added. “It also trims its exposure to stocks whose valuations expand relative to their peers and increases exposure to those whose valuations compress when it rebalances.”
Over the past five years, PRF has also outperformed a value-focused Russell 1000 ETF, the iShares Russell 1000 Value ETF (NYSEArca: IWD), which advanced an average 18.8%. Value investments have been an attractive play this year as investors shied away from growth sectors and shifted into value picks. IWD is up 9.1% year-to-date.