When it comes to innovation, there’s hardly any segment in the financial sector that can beat the exchange-traded funds industry. With more than 1,700 products and about $2.1 trillion in assets under management, it all points to an industry that flourishes on novelty and is more dynamic than every before.
It’s no surprise then that a new product with a brand-new investment strategy hit the blocks recently, for offering another way to dice the S&P 500 index with an aim to give tailor made exposure in large-cap stocks.
The newly launched Elkhorn S&P 500 Capital Expenditures Portfolio (CAPX) is the first ETF from Ben Fulton-founded Elkhorn Investments LLC. Fulton is an industry veteran who headed Invesco Powershares’ Global ETF division and founded Elkhorn in 2013. Fulton, credited with turning Invesco into a leader of alternative indexing, has built a team he worked with for decades in the industry, indicating a deep expertise in the so-called “smart beta” category.
The new fund tracks the S&P 500 Capex Efficiency Index, a gauge that identifies 100 large-cap stocks from the benchmark S&P 500 index based on “capex efficiency.” Efficient capital expenditure (capex) is the barometer of capital discipline. Companies that invest capital efficiently generally tend to show higher sales per dollar of capex.
The methodology results in a subset of 100 equally-weighted stocks that are experiencing specific trends in cash inflows and outflows (investing cash flow). With each dollar of free cash, companies generally have four options; 1) pay dividend to shareholders, 2) buyback shares or pay down debt (balance-sheet trimming) 3) keep as reserve in the bank, and 4) invest in new plants or projects.
The fourth option, known as capital expenditure (capex), shows up in the cashflow statement (instead of the income statement as an expense) and is capitalized on the balance sheet only to be depreciated over time. CAPX invests in companies that have a declining trend in capital expenditure to sales ratio (CE/S) since it may indicate growing revenue from every dollar that is re-invested.
The fund’s portfolio first ranks 100 securities based on the CE/S ratio for S&P 500 companies over the last four years. Subsequently, the most recent year’s ratio is divided by the previous three-year average in order to determine the latest trend. The aim is to identify companies that are investing to grow through innovations rather than return money through dividends and buybacks.
With 98 securities in portfolio, the new fund is well diversified and doesn’t face concentration risk. The top three holdings of CAPX include Pall Corp, Newmont Mining and Altera Corp.
Investors, however, should bear in mind CE/S ratio could trend lower for mainly two reasons; i.e. rising sales or falling expenditures. For example, Newmont Mining scaled back capex (capital expenditure) by about 60 percent in 2014 on the back of falling gold prices globally. The decline in revenue during the period was a more moderate 30 percent, leading to a significantly lower CE/S ratio.
On the other hand, energy-giant Exxon Mobil’s revenue fell drastically due to slumping crude prices, but capex remained stable/declined at a more moderate rate, resulting in its exclusion from CAPX.
The fund has an expense ratio of 0.29 percent.
Disclosure: No holdings
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