ETF Specialist

An International Value-Stock ETF With an Unorthodox Approach

Adam McCullough, CFA

 PowerShares FTSE RAFI Developed Markets ex-US ETF (PXF) offers broad, well-diversified exposure to large- and mid-cap developed international equities through an unorthodox approach. Instead of weighting its holdings by market capitalization, the fund weights them by fundamental measures of size, which introduces a contrarian rebalancing technique. This approach allows the fund to efficiently profit from mean reversion in valuations, which should provide an edge over its peers. However, there are cheaper alternatives, limiting the fund’s Morningstar Analyst Rating to Bronze.

The fund starts with the FTSE Developed All Cap ex US Index and selects the largest 1,000 stocks based on their fundamental weight rather than market capitalization. To determine a stock’s fundamental weight, FTSE measures its trailing five-year average sales, cash flow, dividend (if applicable), and most recent book value against the aggregate value of each figure for the portfolio. Next, it averages those figures to set the fundamental weight. When it rebalances annually in March, the fund increases its exposure to stocks that have gotten cheaper relative to their peers based on their fundamentals, and trims positions that have become more expensive. The fund effectively bets against the market by rebalancing this way. This approach gives the fund a value orientation, but could also cause it to overweight stocks with deteriorating fundamentals since it ignores forward-looking market prices.

Adam McCullough, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.