PHILADELPHIA — First Trust Advisors LP is betting that investors will want exchange traded funds that seek alpha.
PHILADELPHIA — First Trust Advisors LP is betting that investors will want exchange traded funds that seek alpha.
The Lisle, Ill.-based firm launched 16 ETFs this month pegged to AlphaDEX indexes, designed to better their benchmarks. But claiming to be able to deliver alpha via an ETF — although somewhat controversial — is nothing new, according to some financial advisers and industry watchers.
“They’re not the only one in that space,” said Sonya Morris, editor of Morningstar ETFInvestor, a newsletter published by Morningstar Inc. of Chicago. “There has been a proliferation of quasi-active ETFs.”
For example, First Trust faces competition from ETF providers such as Claymore Securities Inc. of Lisle and PowerShares Capital Management LLC of Wheaton, Ill., a unit of Amvescap PLC of London, both of which offer ETFs that seek alpha.
Gaining a foothold in the market presents a problem, because it
hasn’t yet been demonstrated that there is much of an appetite for quasi-active ETFs, which follow a quantitative rules-based strategy. The most popular ETFs still are those that track broad, well-known indexes.
Tried and true
Advisers who were the first to use ETFs have been slow to warm to the idea of ETFs that seek to deviate from broad market indexes.
“I don’t advise my clients to take non-market risk,” said Rick Miller, chief executive of Sensible Financial Planning and Management LLC of Cambridge, Mass., an early proponent of ETF investing. But First Trust thinks that it has hit upon the right idea to make its alpha-seeking ETFs a success, said Dan Waldron, a senior vice president.
One of the problems with ETFs that seek to outperform is that they follow indexes with which investors aren’t familiar and that aren’t transparent, he said.
Those concerns aren’t issues with First Trust AlpahDEX funds, because they are based on broad market indexes, Mr. Waldron said.
For example, the First Trust Large Cap Core AlphaDEX Fund follows an index constructed by ranking stocks in the Standard & Poor’s 500 stock index by factors that include price appreciation, sales to price, book value to price, cash flow to price and return on assets.
Other ETFs are based on indexes such as the S&P MidCap 400, and the sector funds are based on the Russell 1000 Index.
The stocks then are ranked according to their score. The bottom 25% are eliminated, and the top 75% are selected for the enhanced index.
There is a lot of skepticism about ETFs that try to generate alpha, Mr. Waldron admitted.
But basing First Trust’s ETFs on well-known indexes such as the S&P 500 and being upfront about the way the ETFs are constructed should help them appeal to investors, he said.
By the numbers
That may be true eventually, but George T. Padula, president and director of The Danforth Associates Inc. in Wellesley, Mass., said he needs to see a track record.
“You don’t want to base your philosophy on an untested strategy,” he said.
Of course, First Trust has 10 years of data that show how well its ETFs would have performed, Mr. Waldron said.
Mr. Padula, however, said he isn’t impressed.
“Back-testing looks great, but it always does,” he said.
It appears that First Trust isn’t going to let such opinions stop it from at least trying to get the message out about its new products.
Over the past year, the firm has built a team of 18 wholesalers spread throughout the country which will focus on selling ETFs to advisers, Mr. Waldron said.
One of the mistakes ETF providers have made in the past is that they have assumed that if they built an ETF, investors would come, he said. That may have been true once, but in the crowded ETF landscape of today, that no longer is the case.
