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Ready-made stock screen funds

Created:
14 April 2008
Written by:
David Stevenson

One of the great financial innovations of recent times has been the growth of tracker index funds, and especially exchange traded funds or ETFs. These are closed end listed funds that track specific indices, and there's a huge variety of them available to private investors.

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Here's how it works. Fund providers scan the markets using quantitative methods based upon fundamental measures of one form or another. The resulting short list of potential, screened shares is then transformed into a specific index, usually provided by a research firm like RAFI or MarketGrader, which is then in turn tracked by an ETF.

Rob Arnett of RAFI in the US and Jeremy Siegel, consultant to ETF provider Wisdom Tree, have conducted detailed research into fundamental ETFs. Arnett's work found that pinpointing stocks that scored well on criteria that includes company sales,/turnover, cash flow, book value and the dividend yield could deliver extra returns of at least 2 per cent per annum over the long term. His proprietal methodology has now been built into various RAFI indices.

Siegel's research has been more focussed on the dividend yield specifically - he's shown pretty much conclusively that high yielding stocks, all factors being equal, deliver greater returns over the longer term, and especially the bigger the company.

Until recently, trying to capture these research findings has meant either depending on the services of an equity income or value fund manager operating an active investment methodology, or doing extensive research yourself. The problem with the former is that far too few fund managers deliver the goods. The problem with the latter is the time commitment.

ETFs, by contrast, deliver on this research at relatively low cost - usually between 0.5 per cent and 0.75 per cent in total expenses per annum with no up front fee.

The simplest fundamental-based funds are based on a dividend yield - they simply weight their holdings towards high yielding stocks. This approach is particularly in evidence at Barclay's iShares unit with its various DJ index products. Deutsche Banks DBX unit also has some dividend-biased funds as does the tiny boutique unit trust fund S&W Munro Fund, managed by indexing fan Rob Davies. These funds are all elegantly simple in that you're basically buying into a basket of stocks that yield well above their national or regional market

SPA provides a series of US based funds that are built on indices managed by research firm MarketGrader. I quite like this methodology as its relatively transpaent and the company is very open to discussing the various fundamental measures used in working out the composition of the index. One of the downsides of this approach is that these exclusively US market funds are biased towards 'growth at a reasonable price stocks".

The RAFI indices are tracked by ETFs from both Powershares and Lyxor in the UK. Developed by Rob Arnett, these target stocks based on sales, cash flow, book value and the dividend yield. Powershares also boasts its own methodology called the Dynamics range. Like RAFI, this targets a similar set of measures although (like RAFI) it's not that open about the exact measures used.

The problem with many fundamentals-based ETFs is that over the past few years, they haven't performed very well. That's perhaps not surprising given their natural bias towards value stocks, which have performed poorly of late, and banking shares, which often sport high yields. However, I think that we're close to the bottom for this sector, and over the next few weeks I'll be looking at various fundamentals sectors, starting with yield-based funds next week.

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