An Alternative To The Usual Alternatively-Weighted ETF

There are over 700 smart beta or alternatively-weighted exchange traded funds in the United States. While there are obvious differences between some of those products, others have subtle differences or are mirror images of previously existing funds.

The Invesco Strategic US ETF IUS, which debuted in September, offers something of a unique take on alternatively-weighted ETFs.

What Happened

IUS follows the Invesco Strategic US Index, which focuses on domestic large-caps stocks with quality features. As is the case with many strategic beta funds, IUS has some value leanings as well.

The fund's underlying index “is designed to measure the performance of high quality, large-sized US companies. The securities are assigned a business-size score based on the equally-weighted average of sales, operating cash flow, total return of capital and book value over the prior five years or life of the security,” according to Invesco.

IUS is home to 540 stocks and is part of a larger suite of five ETFs from Invesco using similar alternative weighting methodologies.

Why It's Important

“Stocks within the selection universe are also assigned a quality score,” Morningstar said in a recent note. “The quality score is the straight average of two factors: efficiency and growth. Invesco measures efficiency as prior year's sales divided by assets. This indicates how effective a firm is at generating revenue from its assets. The growth measure looks at the change in the sales/assets ratio over the past five years.”

The quality factor is sector agnostic, but some sectors consistently display more quality traits than others. To that point, it's not surprising IUS devotes over 34 percent of its combined weight to the technology and health care sectors, two groups that often loom large in dedicated quality ETFs.

Sectors that are often home to highly levered companies usually don't have a lot of quality names. IUS has an approximately 7 percent combined weight to the utilities, materials and real estate sectors.

What's Next

Even with the quality emphasis, IUS has a significant value tilt. Across large, mid and smaller stocks, over 40 percent of IUS's components are deemed value stocks. There are pros and cons to the IUS value tilt.

“Applying a quality screen should help to sidestep many value traps, likely resulting in a smoother ride. That said, there are trade-offs. Omitting a fifth of the selection universe could also throw out some cheap stocks that ultimately bounce back,” according to Morningstar.

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