An Unconventional Play on Value
This fundamentally weighted ETF allows investors to profit from mean reversion in valuations.
Schwab Fundamental US Large Company ETF (FNDX) is an unconventional value index strategy that should do well relative to its large-value Morningstar Category peers over the long term. It offers broad exposure to large- and mid-cap U.S. stocks, but weights its holdings based on fundamental measures of size, including sales (adjusted for leverage), retained operating cash flow, and dividends plus share buybacks, rather than market capitalization. This causes the fund to overweight stocks trading at low multiples of these metrics and underweight stocks trading at higher valuations. At times, these active weightings can add up to sizable sector bets. The fund currently has less exposure to the financial services and real estate sectors than the Russell 1000 Value Index, and greater exposure to telecom, and consumer defensive, and cyclical stocks.
When it rebalances each quarter, the fund trims positions in stocks that have become more expensive relative to their peers and increases its exposure to those that have become cheaper during the past year. These disciplined bets against the market may give the fund an edge against its market-cap-weighted value index peers if and when valuations mean revert. However, this approach can also increase the fund's exposure to stocks with deteriorating fundamentals. This is because the metrics that determine the weightings of the fund's constituents are backward-looking and are usually slower to detect souring prospects than market prices.
Alex Bryan does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.