| NEW YORK
NEW YORK May 7 Exchange-traded funds that
choose stocks based on alternative growth, momentum and value
factors are winning U.S. investors in the European equities
market as they outperform the traditional market-capitalization
These U.S.-listed ETFs, known as smart beta funds, exist in
the space between active and passive management. They take a
rules-based approach, buying companies that are components of
indexes that are created by weighing factors like dividend
yield, sales growth or stock price moves.
That approach skews these indexes away from the largest
multinational companies, which tend to trade at higher
price-earnings multiples than small- and mid-cap companies.
The approach currently is proving attractive in Europe,
which is in economic recovery.
"As the markets emerge from a recession, smaller and mid-cap
stocks do better as they're more tied in with the local
economies," said Todd Rosenbluth, director of ETF and mutual
fund research at S&P Capital IQ.
WisdomTree's Europe SmallCap Dividend Fund,
which is up 8 percent year-to-date, and First Trust's Europe
AlphaDEX Fund, which is up 6.7 percent year-to-date, are
outperforming their benchmarks -- the MSCI Europe Small Cap
Index, up 5.9 percent year-to-date, and the MSCI All Country
Europe Investable Markets Index, up 3.7 percent, respectively.
First Trust's STOXX European Select Dividend, another
alternatively weighted fund that selects the highest
dividend-paying companies in the region, is up 8.4 percent this
year. These funds are also outperforming broader European
equities ETFs this year.(Graphic of fund performance: link.reuters.com/puh29v)
Investors have responded. WisdomTree's DFE fund has seen its
assets more than double since Jan. 1 to nearly $1.7 billion,
reporting the most asset growth in Morningstar's universe of
some 353 smart beta funds. First Trust's AlphaDEX fund has added
$353 million in assets through the end of April, according to
Morningstar data. With the success of DFE, WisdomTree on
Wednesday launched another Europe dividend growth ETF.
By narrowing in on growth and value factors, the funds allow
U.S. investors to gain exposure to companies like German
telecommunications firm Drillisch AG, which has gained
28 percent so far this year, and Madrid-based construction
company Obrascon Huarte Lain, S.A., up 14.6 percent
this year. Those companies would not be included in a more
traditional market cap-weighted ETF, like the Vanguard FTSE
Europe ETF and the iShares MSCI EMU ETF, because
of their sheer size.
The smart beta ETFs allow investors to be more granular in
their choices, said David Garff, president of Walnut Creek,
California-based Accuvest Global Advisors.
"Yes, I do like Europe, but I like specific parts of Europe,
not Europe in general," he said.
GROWTH IN SMART BETA
Non-market-cap-weighted ETFs, also referred to as "strategic
beta" and "alternative beta" by many in the industry, are part
of one of the fastest-growing segments of the global $2.4
trillion ETF market, according to analysts.
"Both institutional and retail investor interest in these
strategies have accelerated in the past several years," a group
of Moody's analysts wrote in a recent report. "It still has
substantial room to grow."
Between 1969 and 2011, traditional, market cap-weighted
indexes lagged the alternatively weighted indexes by as much as
2 percent a year, according to a study from Cass Business School
in London published last year.
But the smart beta ETFs are not without risk. Should Europe
pivot to a recessionary economy, these funds could fall faster
than their plain vanilla counterparts.
"If the European economy shows signs of weakness and or
certain local European markets show signs of weakness, then
these ETFs because of their smaller-cap nature are more likely
to get hurt," Rosenbluth said.
In 2011, for example, as the broader European equities
markets sold off, WisdomTree's DFE fund fell 23.3 percent, while
Vanguard's VGK fund fell only 15.6 percent.
Furthermore, these strategic funds often come at heftier
Management fees for the First Trust AlphaDEX ETF are $80 a
year for every $10,000 invested, while the Vanguard VGK ETF, a
market-cap fund, charges only $12 for every $10,000 invested.
Compounded over years, that can make a significant difference to
a long-term investor.
Jonathan Horton, president of global index provider FTSE's
North America group, said he has already seen a growing number
of ETF issuers coming to FTSE who are interested in building
funds based on alternatively weighted indexes.
"There's a high level of competitive drive for
differentiation," Horton said. "Unambiguously we've seen more
demand for beta strategies."
(Reporting by Ashley Lau; Editing by Linda Stern and Leslie