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Market Cap Vs Fundamentals: How ETF Weighting Strategies Could Impact the Average Investor

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Exchange-traded fund weighting strategies are starting to really matter for investors.

Longtime market watcher and Wharton School professor Jeremy Siegel has argued for decades that investors should consider alternatives to popular market cap-weighted funds, particularly ETFs that weigh their holdings based on fundamental factors such as earnings growth, dividends or momentum.

Now, that tide is slowly turning. Though market cap-weighted funds are still the most widely held in the $5 trillion ETF market, issuers are growing increasingly comfortable offering factor-weighted and other niche products.

WisdomTree launched its own U.S. Growth and Momentum Fund (WGRO) in late June based on some of the factors highlighted by Siegel, an advisor at the firm. The ETF tracks the O'Neill Growth Index, which uses growth investor Bill O'Neill's strategies to find high-potential plays trading at discounts.

Jeremy Schwartz, executive vice president and global head of research at WisdomTree, said success for either strategy depends on the market backdrop.

"Cap weighting does incredibly well in these growth-oriented markets that you've had for the last 15 years," he told CNBC's "ETF Edge" this week. "Where fundamentals start to work is when things get really dislocated."

When markets get too expensive, rebalancing towards earnings growth and dividends can prove helpful, Schwartz said.

Though WGRO tracks an index, it will rebalance monthly and have some of the highest turnover in the market, making it more active than even some actively managed funds, he said.

"Being active in this higher-growth area, the innovation area and the SPAC area ... could be very useful," he said. SPACs are special purpose acquisition companies that serve as blank checks for entities seeking to go public.

For WallachBeth Capital managing director Andrew McOrmond, choosing whether to invest based on market cap or fundamentals "really has to come down to your time horizon."

"If your average investor is 35 years old, then they can stay the course with the market cap weighting if they're going to retire at 65," he said in the same "ETF Edge" interview. "But if you're 60 years old right now, with valuations where they are, … you don't want to be on the wrong side of that trade when it happens."

WGRO is definitely more suited to young investors, McOrmond said.

"You need to get all that growth and upside. And I believe the expense ratio is more than reasonable to justify being in this ETF to be ready for some kind of downturn as well," he said.

Mark Yusko, who runs a SPAC-based ETF, said in the same "ETF Edge" interview that the real debate isn't between market cap and fundamental weighting, but between market cap and equal weighting.

"That's the big difference. If you buy the S&P 500, 5-6% of it's going to Apple whether you think that's a good buy or not. And there's no choice, there's no decision, there's no thought," the Morgan Creek Capital Management CEO and chief investment officer said.

"With an equal-weight portfolio, you've got more opportunities for rebalancing and that monthly rebalancing — we have a similar cadence to our ETF — I think is really important," Yusko said.


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