First, Trust Russell

September 13, 2006

With all the stocks ranked, Russell then lops off the bottom 25 percent. The remaining 75 percent is broken into quintiles, with the best-scoring quintile of stocks given the highest weight, the next group slightly lower weightings, etc.

The funds are rebalanced quarterly.

Unlike many quant strategies, these new funds ignore the analyst community entirely - there's no mention of meeting or beating analyst expectations, or of adjusting for rising expectations.  The strategies also put no value on future expectations: there's no accounting for expected earnings growth, sales growth or cash flow.  Russell would likely argue that the stock price momentum gauge captures that, but it's not quite the same thing.  That could be good - or bad - time will tell.

"One of the differentiating factors compared to other ETFs, and particularly the SPDRs, is that we start with the Russell 1000, which includes both large and mid-cap stocks," says Waldron.  "A lot of large-cap fund managers have the ability to move into the mid-cap range, and the AlphaDex (products) do as well."

Proof In The Pudding

Ultimately, the question for these products is: will they perform?  The growth and value screens are intriguingly simple, and make some intuitive sense - select good growth stocks and good value stocks, and there you go.

The funds will face an uphill battle.  After all, most alpha-seeking strategies fail - that's why indexing is the best investment solution for most investors. The fact that these and other quantitative funds are on autopilot helps, as it frees them from emotional mistakes and classic behavioral finance lapses.

Still, the funds will face an uphill battle, not the least because of fees. First Trust made no mention of fees in its prospectus, but it charges 65 basis points for the DB Strategic Value fund, and the new funds will likely charge a similar amount.  By comparison, the SPDR sector ETFs from State Street charge just 24 basis points.

Performance aside, the challenge for First Trust will be stealing mind share from PowerShares, which has a tremendous lead in the alpha-generating ETF industry.  Although First Trust's transparent methodology is an advantage, PowerShares has built up some fairly serious live performance data: Its flagship fund, the PowerShares Dynamic Market Portfolio (AMEX: PWC), has beaten the S&P by nearly 20 percent over the past three years, although it has lagged recently.

How First Trust will market against that performance record remains to be seen.  But partnering with Russell was a good first step.

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