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Using A Strategic ETF To Outperform The Market

The document discusses strategically indexed ETFs and how they can potentially outperform passively indexed ETFs like SPY. It provides the example of the ProShares 130/30 fund (CSM), which uses rigorous fundamental and technical analysis to determine stocks to short and overweight in its portfolio. CSM maintains a net market exposure of $100 but aims to outperform SPY by shorting $30 of stocks expected to underperform and investing $130 including the short sale proceeds in stocks expected to outperform. While CSM has outperformed SPY so far, it also carries higher costs and risks than passive index ETFs due to its strategy.

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Lamico Dellavvoltoio
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60 views

Using A Strategic ETF To Outperform The Market

The document discusses strategically indexed ETFs and how they can potentially outperform passively indexed ETFs like SPY. It provides the example of the ProShares 130/30 fund (CSM), which uses rigorous fundamental and technical analysis to determine stocks to short and overweight in its portfolio. CSM maintains a net market exposure of $100 but aims to outperform SPY by shorting $30 of stocks expected to underperform and investing $130 including the short sale proceeds in stocks expected to outperform. While CSM has outperformed SPY so far, it also carries higher costs and risks than passive index ETFs due to its strategy.

Uploaded by

Lamico Dellavvoltoio
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Using A Strategic ETF to Outperform the Market

learningmarkets.com/using-a-strategic-etf-to-outperform-the-market/

By John Jagerson March 31, 2009

Editor's Note: You can find our complete library of free investing articles here.

There is a difference between an ETF that is mostly passively indexed versus one that is
strategically indexed. The ETF SPY is a good example of the former and this article will
discuss a another good example of the latter. You may find that the growing pool of
strategically indexed ETFs makes an interesting addition to your portfolio.

[VIDEO] Behind the 130/30 Fund

The criteria for inclusion in the S&P 500 stock index includes; market capitalization,
location, liquidity, sector representation and some simple fundamental data. The
requirements don’t necessarily need to be more rigid to be a very efficient representation
of the stock market overall. The SPY is able to replicate this index with a very high degree
of efficiency.

By contrast, an ETF that I would call “strategically” indexed would include much more
rigorous fundamental and technical criteria. The ProShares 130/30 fund (CSM) is a good
example of such an ETF. The fund looks for a lengthy list of positive and negative
fundamental characteristics when evaluating stocks to short and stocks to buy.

For each $100 invested in CSM the fund will short $30 worth of stocks that the strategy
would indicate have a negative expected return. The fund will then purchase $130
(which includes the $30 proceeds from the short sale) worth of stocks with positive
expected returns.

The total portfolio now still has a net market exposure of $100 ($130-$30=$100) but
could outperform a more passively indexed ETF. As you can see in the chart below, so far
this ETF has been able to outperform the SPY.

There are some unique risks of funds like this that include higher costs and a limited
track-record. For example, this fund has an expense ratio of .95%, which may be lower
than many mutual funds but is several times higher than the expense ratio of the SPY
ETF. This increases the height of the hurdle CSM will have to beat just to match the
returns on the SPY over the long term.

Strategically indexed funds may be able to outperform an individual investor trying to


execute a similar strategy through individual stocks because they have efficiencies in
scale. It is also a lot simpler process to just buy an ETF than to do the required analysis
yourself. For these reasons CSM may be an interesting opportunity for investors looking
for a little more diversification.

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Image courtesy Cia Gould.

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