The bull market rages on thanks to quelled fears surrounding the political situation in Washington D.C. and upbeat reports and outlooks from a number of bellwethers on Wall Street this earnings season. Amid all of the euphoria, it’s easy for many to get caught up with which broad-based equity benchmark is leading the charge; the most popular suspect for gauging domestic stocks is State Street’s (SPY, A), which is linked to the S&P 500 Index [see Visual History Of The S&P 500].
Although SPY boasts unparalleled liquidity and is undeniably the most well-known ETF on the market, this fund may be less than ideal as a buy-and-hold instrument for those in search of U.S. large cap exposure over the long-haul.
SPY’s massive portfolio of nearly $159 billion in assets under management is hard to pass up for any new buyers looking to enter a well-established fund; however, upon closer review, First Trust’s Value Line Dividend Index Fund (FVD, A-) may actually offer a more compelling case than its much larger counterpart [see Free ETF Head-To-Head Comparison Tool].
FVD Flying Under the Radar
This ETF launched on 8/19/2013 and has since managed to accumulate close to $750 million in total assets under management. What’s impressive here is the fund’s 10-year track record; as of the end of last quarter (9/30), FVD has returned 9.68% over the last decade, compared to SPY, which returned 7.46% over this same period. These two ETFs are linked to different benchmarks, but FVD’s outperformance is still very impressive when considering the fact that it also focuses on U.S. large cap stocks.
So what’s the reason behind this difference in performance? The methodology. Unlike SPY, which is linked to the S&P 500 Index, FVD uses this same benchmark as a reference point when constructing the underlying portfolio. The First Trust ETF starts with a universe of U.S. large cap securities that it then ranks using the Value Line Safety Ranking System. Next, the stocks with the highest ratings that also have a dividend yield above that of the S&P 500′s are selected for inclusion; in an effort to weed out volatile prospects, FVD then eliminates all companies with a market capitalization of less than $1 billion and equally-weights the rest [see Monthly Dividend ETFdb Portfolio].
The result is a portfolio consisting of high quality stocks that also boast above-average yields. The fact that FVD is equal-weighted inherently gives more exposure to smaller companies, which ultimately allows it to outperform its market cap-weighted counterpart, SPY, since smaller stocks have historically outperformed their larger counterparts during bull markets [see 101 High Yielding ETFs For Every Dividend Investor].
From a total return perspective, meaning closing prices are adjusted for dividends before calculating returns, this difference in methodology has allowed FVD to outperform SPY by an even wider margin. Consider the cumulative returns comparison over the last 10 years below. Note that this is based on adjusted close trading data spanning from 10/17/2003 to 10/18/2013, and as such, it accounts for the difference in distributions that each of the funds has made over the past decade; note that this example does not account for the difference in expense ratios between the two ETFs:
Not surprisingly, FVD is leading the charge thanks to its focus on above-average yielding stocks that also boast quality fundamentals according to its “safety” rankings methodology. As of 10/23/2013, SPY boasted an annual yield of 1.95% compared to FVD’s distribution yield of 2.48%; FVD has historically boasted a higher yield than SPY and the effects of compounding reflect this in the cumulative returns graph above.
To be fair, SPY charges 0.09% in annual expense fees while FVD boasts a steep price tag of 0.70% annually. Thus far, the more expensive FVD has produced worthwhile results; although for traders and cost-conscious investors, SPY is tough to beat [see The Cheapest ETF For Every Investment Objective].
The Bottom Line
When shopping around for an ETF, remember that bigger isn’t always better. While it’s undeniable that a solid base of assets and a long operating history generally make for a safer investment, there are plenty of smaller funds out there that warrant a closer look under the hood.
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Disclosure: No positions at time of writing.