Barron’s 400 ETF increases mid-cap exposure following index review

Sep 21st, 2016 | By | Category: Equities

The Barron’s 400 ETF (NYSE: BFOR), a smart beta exchange-traded fund tracking the Barron’s 400 Index, has increased its allocation to mid-cap companies following the semi-annual reconstitution and rebalance of its underlying benchmark.

Barron’s 400 ETF increases mid-cap exposure following index review

Carlos Diez, CEO and Founder of MarketGrader.

The index, co-created by Barron’s, a leading US financial journal, and MarketGrader, an independent equity research and indexing firm, tracks the performance of 400 US companies selected based on the strength of their financial statements and the attractiveness of their share prices.

The engine behind the index’s methodology is MarketGrader’s proprietary equity rating system, which assigns nearly all investable US stocks a grade on a scale of 0-100 based on a combination of 24 fundamental indicators across growth, value, profitability and cash flow, picking the top ranking companies after screening for size, sector diversification, and liquidity. The index’s constituents are equal weighted, each representing 0.25% upon rebalance, eliminating the tendency in traditional market capitalization weighted indices of the largest companies to disproportionately impact performance.

To maintain the growth at a reasonable price (GARP) investment philosophy, the index is reconstituted and rebalanced twice a year, removing firms whose fundamental quality may have been eroded or whose share price no longer represents an attractive buy.

Upon rebalance, the index saw a significant substitution of large-cap for mid-cap stocks. The net loss of 22 large-cap components brought its size allocation to 16.75% in the index. The net loss of large-caps was replaced by a net gain of 18 mid-cap and four small-cap companies. With 244 constituents, mid-caps comprise the majority of the index with a 61% allocation. Small-caps encompass 89 names for a 22.25% allocation.

Carlos Diez, CEO and Founder of MarketGrader, believes the shift in favour of mid-cap companies is indicative of the strength and resilience of the US domestic market: “Once again, we saw [the index] composition shift smaller. Large-caps’ higher exposure to lower-growth overseas markets continues to contribute to their decline in the index. MarketGrader’s fundamental GARP ratings find more favour currently with smaller companies that derive a higher proportion of their business domestically. This is suggestive of the relative health of the US economy and the attractiveness of the domestic market as a location for investors seeking capital appreciation, particularly the mid-cap growth segment.”

On a sector basis, materials had the biggest net gain in number of constituents, adding 6 components and resulting in a 4% overall weight in the index. Health care saw the second largest net gain, with 3 additions pushing the sector’s allocation to 12%. Consumer discretionary had the biggest net loss – shedding 6 constituents – but at 18% overall composition, it remains the third most represented sector. For the third consecutive selection period, financials and industrials both reached the maximum sector allocation of 20%, or 80 companies.

Diez added: “[The index] continued significant allocation towards companies in cyclical sectors speaks to the strength of the fundamentals underpinning the US economy. At the industry level, one theme that stands out with this reconstitution is homebuilding and construction. By our count, nearly one quarter of the constituents in the new index class are dependent on the housing market. With an index that chooses its members on the basis of their fundamentals and the attractiveness of their share price, this indicates the significant benefits the housing market is providing these companies, and hints at the opportunities for investors. Long a bellwether for economic activity, the string of good data coming out of the housing market recently, corroborated by the health of these components, suggest doubts about the ability of the domestic economy to absorb further rate increases are overblown.”

Prominent large-cap additions include Citigroup, Constellation Brands, Intercontinental Exchange, Microsoft, Nvidia, Qualcomm and Raytheon. Notable large-cap deletions include Berkshire Hathaway, Intel, Johnson & Johnson, Union Pacific, UnitedHealth Group and Verizon Communications.

The reconstitution has helped elevate the fundamental health of the index. The average MarketGrader score for companies within the index is now 67.8, compared to 66.5 for the March selection class. Outgoing companies had an average score of 54.9, representative of their diminished appeal, while incoming selections had an average score of 66.1.

In total, 172 companies were added to the index upon rebalance, a turnover rate of 43%, in line with the average of 42% since inception. A total of 82 companies have been members of the index for at least 2 consecutive years (4 reconstitutions). Of this group, 50 have been members for at least 3 years and 19 have been members for at least 5 years.

The ETF has a total expense ratio of 0.65%.

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