Thu, 24 Jul 2014
With its size-meets-value approach, this large-cap fund could be a suitable core holding.
Alex Bryan: Unlike most ETFs, iShares Enhanced US Large-Cap does not track an index--rather it applies a rules-based investment approach to target stocks with value, quality, and smaller-cap characteristics. It may seem odd that a large-cap fund would introduce a small-cap tilt. By itself, size has not been a great factor and, theoretically, adding a small-cap tilt to a large-cap fund should have an even smaller impact than overweighting small-cap stocks directly. But the value premium has historically worked the best among smaller-cap stocks; therefore, combining size with value is a reasonable approach.
Putting quality and value together is also a prudent approach because it may help the fund reduce its exposure to value traps, which are stocks that look cheap but may become cheaper. It may also help the fund avoid overpaying for quality.
The fund measures quality using earning stability, low debt/capital ratio, and earnings accruals. In other words, it's looking for stocks that have high operating cash flow relative to net income. Earnings accruals are a reasonable proxy for quality because the cash component of earnings tends to be more persistent than the accruals piece. Unfortunately, the fund does not consider profitability directly. That's arguably one of the most important ways to look at quality because it shows how productively a firm has used its assets.
The fund anchors its sector weightings within 10 percentage points of the Russell 1000 Index and optimizes its portfolio to target 90% of the volatility of the market. These constraints allow investors to use this fund as a suitable core holding.
While most complex investment strategies tend to be expensive, this fund only charges 18 basis points. It's only been around for about a year, so it's still pretty thinly traded. Therefore, it may be a good idea to wait until it gains more assets before buying, but it's definitely a fund to watch.