RevenueShares Investor Services LLC became the latest firm to enter the exchange traded fund market Friday, launching three ETFs based on indexes weighted by the amount of company revenue.
But at a time when ETF providers — to say nothing of ETFs themselves — are sprouting like weeds, some industry experts are questioning whether the new firm will make it.
COMPETITION A PROBLEM
At the end of last year, there were 629 ETFs in the United States — managed by 19 ETF managers, five of which emerged last year.
Total ETF assets were approximately $608 billion, most of which (80%) were controlled by
Barclays Global Investors of San Francisco or
State Street Global Advisors of Boston.
Such competition is a major problem for new entrants, said Jim Lowell, Needham, Mass.-based editor of Forbes ETF Advisor, a monthly newsletter.
ETFs that advertise themselves as "new and potentially better mousetraps" may in fact be worth investing in, but they must be judged on real-world performance, he said.
Back-testing — whereby providers show how their ETFs would have performed — isn't good enough, said Mr. Lowell, who is also a partner and chief investment strategies in Adviser Investments, a Newton, Mass.-based adviser with $1.4 billion under management.
That's a problem for new entrants because it means it could be years before their products have a real-world track record acceptable to advisers.
It is a challenging market in which to launch an ETF, agrees Sean O'Hara, president of Paoli, Pa.-based RevenueShares.
But RevenueShares has hit upon an idea he believes investors will find appealing.
Rather than present investors with a completely unknown new index, RevenueShares based its initial ETFs on well known indexes: the Standard & Poor's 500, Mid Cap 400 and Small Cap 600 stock indexes.
The ETFs themselves will be advised by VTL Associates LLC of Philadelphia.
While it's true that the indexes will be weighted by revenue instead of market capitalization, it's not as if investors will have no familiarity with the indexes, Mr. O'Hara said.
And once investors look at the advantages of weighting the indexes by revenue, the value proposition of investing in such ETFs will become clear, he said.
Back-testing performed by Standard & Poor's of New York has indicated higher returns for a revenue-weighted index, compared with those for market-cap-weighted indexes.
For example, the RevenueShares LargeCap Index, upon which the RevenueShares Large Cap Fund (RWL) is based, outperformed the S&P 500 and large-cap indexes from Russell Investments of Tacoma Wash., for the three-, five- and 10-year annualized periods ended Dec. 31.
Whether one believes in back-testing or not, it does appear that there may be some value to weighting indexes by revenue, said Jeff Ptak, director of exchange-traded-securities analysis at Morningstar Inc. of Chicago.
When he revenue-weighted the S&P 500 as of Jan. 31, the resulting portfolio was trading at a 17% discount to what Morningstar analysts believe it's worth in aggregate, he said.
That slightly exceed the 15% discount at which the S&P 500 SPDR (SPY), from SSgA, was trading as of Feb. 13, Mr. Ptak said.
That works out to roughly 1% per annum in incremental expected annualized returns, he said.
That's not bad, but any potential returns the ETF might have realized would have been rendered virtually meaningless by its 0.49% expense ratio, Mr. Ptak said.
The S&P 500 SPDR has an expense ratio of 0.08%.
"Reordering [the S&P] by revenue, I suppose that's a legitimate way to rank the order, but its not like splitting the atom," Mr. Ptak said. "I question why the management fee is so high."
It's even higher for the RevenueShares Mid Cap Fund (RWJ) and RevenueShares Small Cap Fund (RWK), both of which have expense ratios of 0.54%.
While the expense ratios are higher than those of some ETFs, they are also lower than those of others — especially "fundamental" ETFs based on indexes that eschew traditional weightings based on market cap, Mr. O'Hara said.
"We tried to pick a price point that ... satisfies a fair value for what we're offering," he said.
OTHERS IN THE WORKS
Only time will tell if investors find the company's ETFs appealing.
RevenueShares, however, is confident in the concept of revenue-weighted indexes. It has plans in the works to launch ETFs based in revenue-weighted style indexes, and soon hopes to offer revenue-weighted international indexes, Mr. O'Hara said.
David Hoffman can be reached at [email protected].
