Best Of 2016: This Year's Most Innovative New ETFs

November 03, 2016

PSETPrincipal Price Setters Index ETF
Warren Buffett once famously said that when picking stocks, a company's management team mattered less to him than its pricing power, or the firm's ability to raise prices without affecting demand.

The idea makes sense: Companies with plenty of pricing power tend to face little competition in their markets. They can easily pass through cost increases to their customers, unlike firms that rely on competitive prices to attract and retain customers. Strong pricing power, therefore, can translate into sustainable sales and earnings growth, even during market downturns.

However, pricing power isn't easily quantifiable. As such, it's a tricky concept to use as the basis for an index product.

That hasn't stopped one fund from trying, however. The new PSET is a smart-beta fund that aims to track U.S. mid- and large-caps primarily by their pricing power.

The index pulls securities from the Nasdaq US Large Mid Cap Index and ranks them based on 11 factors, including sales growth, operating margins, return volatility, return on equity and earnings quality. (Interestingly, market share is not taken into account.)

The 11 factor scores are then averaged into one final score to determine pricing power. The top 150 securities make it into PSET's index.

Holdings are equally weighted within three rankings tiers: The top 50 securities comprise 50% of the index; the securities ranked from 51 to 100 comprise 35%; and the securities ranked from 101 to 150 comprise 15%. The index rebalances annually.

With no sector caps in place, PSET's portfolio could drift away from the composition of the broad U.S. market. For example, as of Sept. 23, 2016, industrials comprised the biggest portion of PSET's index (28%), whereas they only make up 13% of the S&P 500.

 

JSMDJanus Small/Mid Cap Growth Alpha ETF
Even though growth investing is essentially a bet on the future, many investors sell off their growth stocks as soon as markets become volatile, resulting in missing out on the long-term upside of such companies. After all, you have to give a growth stock time to, well, grow.

JSMD aims to soothe jittery nerves with what Janus calls "smart growth," or a growth strategy that stays the course in volatile markets, so as to capture potential long-term outperformance. 

JSMD is based on the popular actively managed Janus Triton Fund, with a passive indexing twist.

The fund's index evaluates U.S. small- and midcap stocks based on their fundamentals in three key areas: growth, profitability and capital efficiency. Janus scores companies for each of these three factors using 10 financial indicators, including revenue growth, margins, profits, return on capital and earnings per share. Then the three scores are totaled to give one final ranking. The top 10% stocks are included in the index. 

JSMD's index weights holdings by sector, so as to match the sector allocations established in the Triton Fund. (Within each sector, stocks are market-cap-weighted.)There are no sector caps, but no one individual company may comprise more than 3% of the index.

So is JSMD passive, or active? A little of both. However, at 0.50%, JSMD's expenses come in 41 basis points lower than the active fund on which it's based, which should make the ETF more attractive to comparison shoppers.

DDWMWisdomTree Dynamic Currency Hedged Int'l Equity Fund
Whenever you invest in a foreign stock, you also—intentionally or not—take on currency risk. That's why many investors use hedges to cancel out the effects of local currency on their international portfolios.

But currency risk isn't always a bad thing. If you hedge, you may miss out on occasions when moves in the local currency could have boosted your returns.

DDWM aims to capture this lost opportunity by using variable currency hedges. These hedges, which change month to month, are cued by three equally weighted signals.

DDWM's index includes dividend-paying stocks from 21 international developed markets, excluding the U.S. and Canada (and South Korea). Stocks are weighted by the total cash dividends paid over the past 12 months.

The index also rebalances annually, so that companies with falling stock prices but flat or rising dividends are weighted more heavily than those with rising stock prices but falling dividends.

A hedge amount between 0 and 100% is then calculated for each local currency. For example, as of Sept. 23, 2016, the fund was 50% hedged to the euro and Japanese yen, but 83% hedged to the British pound.

To determine each hedge ratio, WisdomTree compares the local currency to the U.S. dollar using interest rate differentials (or "carry"), momentum and valuation.

This hedging strategy is similar to the iShares Adaptive Currency Hedged MSCI EAFE ETF (DEFA), which implements hedges stepped in 25% increments. DEFA also calculates its hedge amounts using similar metrics: carry, momentum, value and volatility.

DDWM, however, tracks a fundamentally weighted index specifically slanted toward dividend-paying companies, whereas DEFA's benchmark is a hedged version of the market-cap-weighted MSCI EAFE Index.

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