How Revenue Weighted ETFs Work

February 28, 2017

OppenheimerFunds is known for its revenue-weighted ETFs, which today command nearly $2 billion in combined assets. The lineup of nine ETFs includes the likes of the Oppenheimer Large Cap Revenue ETF (RWL) and the Oppenheimer Small Cap Revenue ETF (RWJ), each with more than $520 million in assets.

Sharon French, head of beta solutions for the firm, tells us what’s unique about revenue weighting, when it works best and how it compares to market-cap and price weighting—two hugely popular approaches in U.S. equity investing. Why do you think revenue weighting is a better approach to equity exposure relative to price weighting and market-cap weighting?

Sharon French: It gives you diversified exposure to the market, but it's not influenced by stock price. It's a truer indicator of a company's value, because it can't be manipulated by accounting practices. And it provides better and more stable sector exposure, because top-line revenue really tends not to fluctuate as much as stock price.

Using market-cap weight, you have an issue that relates to trendier sectors or overvalued stocks. From a risk management perspective, this is a better way to go. Revenue  weighting returns an index to its real economic footprint. Your research looks into different predictors of a company's value, and it argues that price-to-sales is the best predictor. Why? And how is that metric captured in a revenue-weighting scheme?
Our research shows that price-to-sales is the best indicator of future returns, compared to other common value weights of metrics such as price-to-earnings, price-to-cash-flow, price-to-book. Of all of these, it has the highest predictive power for 10-year returns. A revenue-weighted ETF takes an underlying basket of stocks and it right-sizes them based on their revenue. A byproduct of this is lower valuations, and specifically price-to-sales.

The reason we grew assets 100% in our first year is because advisors really understand this. That really helps them lower the price-to-sales of a particular asset class or core allocation in their book. Revenue itself is not a traditional factor, but does a revenue-weighted portfolio capture some of these factors? Should it be considered as a quality portfolio?

French: That’s the right way to think about this. Revenue’s not one of the traditional factors. If you think about smart beta being equal weight, fundamental weight, single factor, multifactor, it fits squarely in the fundamentally weighted methodology within smart beta. Revenue weighting does two things to the factors in a portfolio.

First, it tilts the portfolio toward value. Value investing takes discipline, and it's been shown to outperform expensive companies over long periods of time. Value has had an incredible run since the elections, and a lot of people are saying we're going into a more permanent value cycle.

Second, it reduces the portfolio's momentum. Revenue doesn't really trade off of price. And like most value strategies, it takes a contrarian look at the market's expectations. While we recognize momentum as a long-term driver of return, sometimes its volatility and drawdowns are high.


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