Saturday, April 30, 2011

ETF Ranking: Related Research

I was browsing on the web for related research on ETF ranking. My first impression is that this topic is overly crowded. Just look at how many Google ads associated to the keyword when you Google "ETF ranking".

Then I noticed that my blog post "ETF Ranking, Sector Rotation, And Business Cycle" is at the 6th place on Google. Not bad considering I've started this blog only a month ago.

OK, this is not the purpose of this post. The purpose is to give an overview on others' research on ETF ranking.

First, something about fundamental ranking.

Fluent investors may have noticed the similarity of my fundamental ranking system and Greenblatt’s magic formula. Although I didn’t know about magic formula when I started to work on my ranking system, I do agree with Greenblatt in many fronts. He suggests using magic formula on large groups of stocks, that’s why I settled with ETF ranking. He also commented that once applied to large groups of stocks, any differences between the various return on capital formulas will not have much effect on the performance. I'd like to use this as an excuse of not revealing my formulas.

Now on ETF ranking. It appears that many companies provide ETF ranking as a financial service to investors. Enumerating all service providers is not my purpose. I just try to enumerate all different approaches, and pick one representative website for each approach. And by no means the list is complete. I stopped at about page 4 on Google.

A little bit brag first: although there are many different approaches, none of them provides data to show the relation of their ranking system and short term return, at least I didn't see any public data. It appears that my ETF ranking is the only one that is designed for short term return and has data to show the strong statistical relation between ranks and short term return.

Enough for bragging.
  1. XTF’s structural integrity. ETFs are ranked based on (a) Tracking error, (b) Efficiency: daily alpha before expenses, (c) Market Impact, (d) Concentration Risk, (e) Tax Efficiency: Capital Gains, (f) Expense Ratio, and (g) Bid-Ask Ratio. No doubt all of them are important for institutional investors. But by no means this is a fundamental based ranking and I'm certain there is less likely to be any relation to short term return.
  2. Admittedly their idea is similar with mine. They first rank stocks in the ETF's portfolio by their risk and reward, and then sum up to the rank of the ETF. Although I don't have additional information, my guess is the risk and reward should have at least some fundamental flavor. And the sum-of-parts approach is the same with mine. Nonetheless, there is no data show the relation to short term return.
  3. Value line. An introduction is here. This is by far the closest one to mine. It is value based, which has to be fundamental. And it is sum-of-parts. However, their ranking system is designed for 6 months to 12 months holding, while mine is for 1 week rebalance. The introduction did say they have one year data to show the performance, though.
  4. Sabrient’s SectorCast model. The rank consists of two parts: fundamental data and analyst's projection of company's future performance, such as forward P/E. The idea sounds brilliant, but I'd like to question the soundness of using analyst's projection. More often than not, analysts are just chasing public opinions. The performance data is not persuading. Actually the best ranked ETFs generated negative return while the market is rallying. Due to this, their model is evolving constantly. The risk is that they are just tweaking the model to fit the curve.
  5. Ranks based on past 3 months or 6 months' performance. Such as The information is good for momentum or trend trader. Both are mysterious and certainly not based on fundamentals.
  6. Ranks based on technicals such as 20 day moving average and 50 day moving average from This is another way to express trend, and certainly not based on fundamentals.
  7. Ranks based on number of new highs and new lows of constitutes from Yet another way to describe the technical strength, and certainy not based on fundamentals.

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