This Promising Investment Just Got a Big Boost

When it comes to most stock indexes, bigger is better. The widely followed S&P 500, and other popular market indexes, use market capitalization as their primary weighting factor, with bigger companies getting more weight in their respective indexes than smaller companies.

But one branch of investing philosophy believes that market capitalization isn't the ideal way to create a portfolio. Instead, proponents of fundamental-strategy investing prefer to look at factors that are more closely connected to a company's business performance. Recently, Charles Schwab (NYSE: SCHW  ) became the latest ETF company to embrace fundamental investing, debuting six new exchange-traded funds. These six ETFs all track indexes created by indexing giant Russell Investments, and they share a methodology that alternative-index pioneer Rob Arnott helped develop. Let's take a closer look at the ETFs and why they might bring better results than traditional index investments.

Fundamentally better ETFs?
The idea behind Schwab's new fundamental index ETFs is simple: rather than tracking market capitalization, the ETFs choose and weight their respective components based on a combination of other factors. For instance, the Schwab Fundamental U.S. Broad Market ETF tracks Russell's Fundamental U.S. Index, weighting components by their retained operating cash flow, their adjusted revenue, and the total money they return to shareholders in the form of both dividends, and share buybacks.

The net impact of this method is to give much-loved high-growth companies that don't yet have the revenue and cash-generating capabilities to justify their elevated stock prices less weight than well-established, slower-growth companies that already have plenty of earnings and cash flow. Just looking at the holdings of the U.S.-based Schwab fundamental ETF makes the differences clear, as three of the four top-weighted companies in the index are energy companies ExxonMobil (NYSE: XOM  ) , Chevron (NYSE: CVX  ) , and ConocoPhillips (NYSE: COP  ) -- slow- to no-growth companies that bring in cash hand over fist. Telecom giant AT&T (NYSE: T  ) also comes in strong at No. 3, thanks largely to the huge cash flow its existing telecom network generates, and the big dividends and buybacks its cash flow helps support.

A growing trend
Schwab isn't the only company to embrace fundamental investing. Invesco's PowerShares has used fundamentally weighted ETFs in the past, and those ETFs have shared the benefits of avoiding overconcentration in highly valued stocks that have subsequently fallen from grace.

The difference here, though, is that Schwab already has strong relationships with many registered investment advisors. The brokerage company hopes to use those relationships to bolster sales of the ETFs, which include exposure not just to large-cap U.S. stocks, but to smaller companies and stocks in international markets, as well.

Should you buy in?
It's hard to argue against investing in companies that produce ample cash flow and revenue, and then use it to return unneeded capital to shareholders. From year to year, fundamental indexes and traditional market-cap-weighted indexes are likely to take turns leading the market higher or lower. Only time will tell whether these indexes will produce the long-term outperformance that they'll need to achieve in order to overcome the slightly higher 0.32% expense ratio they charge their shareholders.

You don't necessarily need fundamental-weighted ETFs in order to make money from your portfolio. Learn more about a few ETFs that have great promise for delivering profits to shareholders in The Motley Fool's special free report, "3 ETFs Set to Soar." Just click here to access it now.


Read/Post Comments (0) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2617887, ~/Articles/ArticleHandler.aspx, 10/25/2014 8:44:18 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement