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Deep Dive: This index ETF is beating the S&P 500 by excluding ‘losers’

Index-fund investors who didn’t sell into a crashing stock market in March should be pleased, as the S&P 500 has returned 1% in 2020. That’s despite a waif of as much as 30% older this year.

Active fund managers want to write-up the S&P 500 Index
SPX,
-0.82%
,
but most can’t do it considering it’s difficult to pick winners and higher fees depress returns.

Will Rhind, the founder and CEO of GraniteShares, explained a passive tideway that aims to write-up the broader market, but not by selecting winners. The strategy of the GraniteShares XOUT U.S. Large Cap ETF
XOUT,
-1.18%

is to exclude companies with weaker growth prospects.

“We think the traditional passive approach, regardless of whether it is a good visitor or a bad company, is fundamentally flawed,” he said in an interview.

XOUT was established Oct. 7. Here’s how it has performed versus the S&P 500 Index since then:


FactSet

XOUT ranks the 500 largest U.S. companies by a fundamental scoring methodology and excludes the 250 with the weakest scores. The ETF is rebalanced each quarter and is weighted by market capitalization. Its yearly expense ratio is 0.60% of assets, which seems upper when compared with a ratio of only 0.09% for the SPDR S&P 500 ETF
SPY,
-0.80%
.
Then again, expenses are included in the ETF’s return, shown above, and it has performed very well versus the S&P 500 Index (which, of course, has no expense ratio). 

Nine months isn’t a long period to compare a fund’s performance to a benchmark. However, this period has been a roller-coaster ride, and the XOUT tideway may request to investors who want a increasingly focused tideway to the stock market, without narrowing lanugo to particular sectors, however hot they may be.

Rhind founded GraniteShares in 2017 without previously working at Barclays Global Investors (which started iShares and was uninventive by BlackRock in 2009) and ETF Securities (acquired by Wisdom Tree in 2018).

He explained that XOUT’s wringer of the 500 largest U.S. companies encompasses seven categories, in no particular order:

  • Revenue

  • Employee growth

  • Research and minutiae investment

  • Stock buybacks

  • Profitability

  • Earnings forecasts

  • Management score

Each visitor is prescribed a numerical ranking, and the lowest 250 are excluded when the fund rebalances each quarter.

Will Rhind, CEO of GraniteShares.


GraniteShares

Rhind said the scoring and rebalancing “avoid companies that are going to be disrupted, or are in secular decline.”

Five biggest companies excluded

Rhind said XOUT is “not a tech fund,” but moreover said technological disruption is one of the threats the ETF is trying to stave when excluding companies. As of July 16, the information technology sector was the ETF’s largest, making up over a third of the portfolio:


GraniteShares

The fund’s fact sheet includes updated lists of top holdings and the largest companies excluded from the fund. Rhind commented well-nigh the five largest companies excluded:

• Procter & Gamble Co.
PG,
0.98%

 is the largest visitor currently excluded from XOUT. “It is not that the data indicate P&G is seriously amiss, merely that the visitor is falling into a pattern of stagnation and atrophy,” Rhind said. He cited decelerating earnings and sales expectations, based on analysts’ consensus estimates. With a very slow rate of sales growth, Procter & Gamble’s management score within the XOUT model is “18% unelevated market average,” he said. “None of this is to say that PG’s prospects are forfeited, simply that the visitor is not at the vanguard of embracing digital disruption, and investors may have largest options available,” he added.

• J.P. Morgan Chase & Co.
JPM,
-0.10%

 was excluded from XOUT surpassing the coronavirus slipperiness for several reasons. These included “decelerating petrifaction growth,” as well as share repurchases that “were funded by borrowed money, effectively, and not from self-ruling mazuma flow,” Rhind said. He moreover said expected revenue and earnings were declining.

• Rhind tabbed Verizon Communications Inc.
VZ,
0.69%

“a leader at divesting human capital,” since it has been “firing over three times faster than the market is hiring.” He moreover cited revenue pressure, with sales “increasing, but at an weak 0.5%.”

• AT&T Inc.
T,
0.97%

 ”is a visitor responding to technological change, as opposed to leading it,” Rhind said. He widow that AT&T’s revenue growth was coming from its Time Warner acquisition, and that it scored low for revenue growth and that it was moreover shrinking its employee base.

• When discussing Coca-Cola Co.
KO,
0.41%
,
Rhind had this suggestion for investors: “Consider the extent that sugar water provides innovation.” He moreover said the company’s expected earnings growth is “in the marrow 2% for the unshortened large-cap space.” He pointed to the coronavirus economy as a terrible problem for Coca-Cola, considering of the disruption to the physical distribution of its products through restaurants, vending machines and sports facilities.

Top holdings

Rhind said for companies selected for inclusion in the XOUT portfolio, “the closest tableau is the ESG world.” Here are the ETF’s top 10 holdings:

Company

Ticker

Share of portfolio

Total return – 2020 through July 17

Apple Inc.

AAPL,
-1.92%
8.5%

32%

Amazon.com Inc.

AMZN,
-2.63%
8.1%

60%

Microsoft Corp.

MSFT,
-1.53%
8.0%

29%

Alphabet Inc. Class A

GOOGL,
-2.03%
5.3%

13%

Facebook Inc. Class A

FB,
-2.30%
3.5%

18%

Johnson & Johnson

JNJ,
1.08%
1.9%

4%

Walmart Inc.

WMT,
-0.90%
1.9%

12%

Visa Inc. Class A

V,
1.19%
1.9%

4%

Tesla Inc.

TSLA,
4.34%
1.6%

259%

Mastercard Inc. Class A

MA,
3.86%
1.5%

2%

 Sources: GraniteShares, FactSet

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