ALPS Holdings, the Denver, Colorado based fund issuer better known for its customized investment products, recently launched a product that seeks to avoid weighting anomaly in different sectors due to security mis-pricings. The newly launched ALPS Sector Leaders ETF (SLDR) is an effort by the company to avoid loss of diversification benefits associated with under– or over-weighting particular sectors.
Market capitalization weighted indexes suffer from one major flaw; they inherently underweight undervalued stocks and overweight overvalued stocks. Additionally, they tend to tilt toward the biggest companies among the constituent stocks.
For example, Apple Inc should account for 1/500 of the S&P 500 Index’s total had the benchmark index been equally-weighted, compared with the roughly 4 percent that it contributes now.
To mitigate the weighting problem, SLDR takes the so-called “smart-beta” route. Most smart-beta products emphasize such “factors” as growth, quality, momentum and low volatility to decide on index constituent weights. However, a simpler approach would be to equal weight all components within an index or portfolio, thus avoiding the large-cap bias of market capitalization-weighted indices.
The passively managed SLDR tracks the S-Network Sector Leaders Index, a gauge constituted of large-cap equities with equally-weighted sector exposures. The new fund focuses on growth and quality on a sector-by-sector basis. The sector leaders are then identified which include 5 stocks in each of 9 Global Industry Classification Standard (GICS) sectors that make up the S&P 500 index. The GICS classification standard combine telecommunications and information technology sector and excludes shares of Real Estate Investment Trusts (REITs).
A two stage screening method is employed to select the five stocks from each of the nine GIVS sectors. First, the stocks are screened for growth parameters, including growth in EPS and sales per share. Next, the securities are ranked based on quality factors such as return on equity and debt-equity ratio. The underlying index is rebalanced every quarter.
Data from past three years show the S-Network Sector Leaders Index reported an EPS growth of 135.5 percent compared S&P 500’s 56 percent while debt-to-equity ratio for the index was calculated at 54.44 percent compared to S&P’s 78.32 percent.
The new fund is likely to face competition from the S&P Equal Weight ETF (RSP), Equal Sector Weight ETF (EQL) and the Russell 1000 Equal Weight Portfolio (EQAL).
SDLR has an annual expense ratio of 0.4 percent.
Disclosure: No holdings