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ETF Specialist

Strategic Beta: Taking the Alpha Out of AlphaDEX

At first blush, this fund's strategy appears complex, but it is essentially a combination of traditional factors and equal weighting.

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Perhaps the biggest surprise in fund flows for exchange-traded products during the past year is the strength of First Trust. The firm has catapulted itself from the 11th largest provider of exchange-traded products to the sixth largest in just one year. Much of the strong flows are accumulating to funds that have been around for years. What has changed is the increasing acceptance of strategic beta. While they may track an index, strategic beta funds are active, so it is no surprise that investors might take a wait-and-see approach before investing, particularly when the methodology appears to be complex and untested. However, of the 23 First Trust AlphaDEX market-cap and sector funds (excluding the international AlphaDEX funds), the average Morningstar Rating is 4 stars, which is truly impressive. Unlike some single factor funds, the methodology behind AlphaDEX is fairly opaque, but their performance warrants a deep dive. 

Starting with either a market-cap segment or a sector, AlphaDEX funds group all stocks into a value bucket or a growth bucket based on the S&P style designation. Separate models are applied to the value stocks and to the growth stocks. Stocks that S&P classifies as core take the higher score from the two models. The model used on value stocks includes book value/price, cash flow/price, and return on assets. Growth stocks are scored using three-, six-, and 12-month price appreciation, sales/price, and one-year sales growth. What is unique about this approach is that value models typically would not use return on assets, which is usually regarded as a quality measure and growth models typically would not use sales/price, which is more of a value measure. While traditional style funds typically split stocks into separate value or growth groups, this fund retains top-scoring stocks from both models. The result of using different models for value and growth stocks and using unique factors is a balanced portfolio with only a slight tilt toward value, yet with growth characteristics similar to a blend fund. 

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Michael Rawson does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.