ETF Spotlight: Large Cap Core AlphaDEX Fund (FEX)

Published on by on December 3, 2014

The ETF world is continually growing, making it more and more difficult for investors of all disciplines to keep up. In an effort to shed more light on some of the more unique products out there, we take a dive into the Large Cap Core AlphaDEX Fund (FEX) from First Trust.

Inside FEX’s Strategy

There are two components to this ETF: its overall structure and its AlphaDEX strategy. AlphaDEX is a strategy that First Trust developed that employs a rules-based, fundamental approach to various indexes and strategies, all the while remaining passively indexed. This strategy has been the basis for a number of ETFs launched by the issuer, many of which have turned in impressive performances over the years.

Behind FEXIn FEX’s case, the AlphaDEX strategy looks at growth factors like three, six, and 12 month price appreciation, sales to price and one year sales growth, and value factors that include book value to price, cash flow to price, and return on assets. This is then applied to the S&P 500 Index. The stocks are ranked and given internal scores based on how they meet the above criteria. FEX then eliminates the bottom 25%, investing only in the top 75% (approximately 375 stocks). From there, stocks are separated into quintiles based on their scores. The better scoring quintiles are given more weight in the fund. All stocks are equal weighted within a single quintile.

Considerations on FEX’s Performance

While the strategy sounds like a good idea, what really matters is if it works in practice. The table below shows the annual returns for FEX and SPY starting in 2008:

Year SPY Return FEX Return
2008  -36.81%  -38.71% 
2009  26.37%  36.86% 
2010  15.06%  20.64% 
2011  1.89%  -0.43% 
2012  15.99%  14.49% 
2013  32.31%  35.97% 

Past performance does not guarantee future results, but FEX has demonstrated that its strategy has the ability to outperform the general market in certain environments. The fund has a slight tendency to outperform in bull periods and underperform in bear periods, an important point to note for any potential investor.

For the most part, FEX will not be much more volatile than the broad market and its performance will closely align with the S&P, straying a bit in either direction. One more important thing to note, because FEX only invests in approximately 375 stocks, it could potentially shift towards mid-cap stocks in one of its quarterly rebalances. Just because it selects from the S&P 500, do not assume that the fund will always offer pure large-cap exposure.

How to Use FEX in a Portfolio

How FEX is used in a portfolio depends entirely on whether or not you buy into its strategy. The fund could certainly be used as a core holding by those who feel that its offers efficiencies over broad-based funds. But for those who are not as convinced, FEX can be used as more of a complement to an already diversified strategy

Investors who decided to enter a position in FEX should know the ins and outs of its strategy and pay attention to its quarterly rebalance, as the makeup of sector and cap-size exposure can be different from quarter-to-quarter. 

The Bottom Line

The AlphaDEX strategy has been one of the most intriguing in the ETF world, helping make FEX into a relatively successful product with quite a unique strategy. As always, be sure to take a look under the hood of FEX to make sure you fully understand how it operates prior to making an investment.

Follow me on Twitter @JaredCummans.

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Disclosure: No positions at time of writing.