Approximately $140 billion of net inflows went into market-cap-weighted equity index ETFs in the first nine months of 2023. The Vanguard S&P 500 ETF (VOO) is an example of such a popular ETF. An additional $65 billion flowed into actively managed equity ETFs like the JPMorgan Equity Premium Income ETF (JEPI). However, $22 billion moved into fundamentally weighted equity index ETFs, while dividend and momentum ETFs had outflows. This is sizable and warrants some added attention.
Fundamentally Weighted Equity ETFs Gaining Ground in First Nine Months of 2023
Fundamentally weighted index ETFs take a company’s financial profile into account, in a similar way that an active manager would. However, the fundamentally weighted funds follow index guidelines rather than allowing for management discretion that could work in favor or against the selection process.
In 2023, the two most popular fundamentally weighted ETFs were the iShares MSCI Quality Factor ETF (QUAL) and the Pacer US Cash Cows ETF (COWZ). QUAL and COWZ added $9.5 billion and $4.1 billion, respectively. These two ETFs have benefited as investors sought relative stability via the equity markets. However, they are built differently than one another as well as new entrants.
What’s Inside Fundamentally Weighted ETFs
QUAL owns shares of companies with high return on equity, stable year-over-year earnings growth, and low financial leverage traits. Eli Lilly, Nike, Nvidia, and Visa are examples of QUAL holdings. COWZ owns companies with high free cash flow relative to its value (free cash flow yield). These include Altria, CVS Health, McKesson, and Valero Energy. Both ETFs are rebalanced on a planned schedule during the year unlike market-cap-weighted ETFs.
QUAL rebalances semiannually and takes a sector-neutral approach. As such, it has a relatively high stake in information technology (29% of assets) and relatively low exposure to energy (5%).