TILT FlexShares Morningstar US Market Factors Tilt Index Fund

2013 was a banner year for the U.S. stock market, with the biggest annual gain for the S&P 500 in 16 years and for the Dow in 18 years. This was largely thanks to the Fed's easy money policy, improving economic conditions and decent earnings growth.

Thanks to this environment, many ETF issuers put out new products, and some fresh firms are taking a stab at the ETF industry as well. In particular, Vident Financial was a big winner last year with its Vident International Equity Fund (VIDI) which amassed more than half a billion in just three months of trading (also see 4 Best New ETFs of 2013).

With this success, it isn’t too much of a surprise that Vident is going back to the well having just launched a new U.S. ETF. This new fund the Vident Core U.S. Equity ETF trades under the symbol of VUSE and is highlighted in greater detail below:

VUSE ETF in Focus

This new ETF looks to track the Vident Core U.S. Equity Index. This is a rule-based index that measures the performance of U.S. companies having high standards of corporate governance and financial reporting along with an efficient management team.

As per Vident, compelling valuation relative to sector peers, earnings quality, growth and market sentiment are the criteria for inclusion in the index, which develops a scoring system on these grounds (see Alternative ETF Weighting Methodologies 101).  

The product will charge investors 55 basis points a year in fees for this screening system and rebalance on a twice-a-year basis. However, the ETF may not be appropriate for low-cost investors, as the fee on this product is a little higher than the average expenses charged by the all-cap equities space. In fact, costs are roughly six times than what investors see in the biggest U.S.-based fund SPDR S&P 500 ETF (SPY).

Holding about 502 assets in total, the index offers symmetric exposure across the capitalization spectrum with small-caps taking the top spot (38%) followed by mid-caps (37%). Companies with $500 million to $2 billion get the highest weight (37.1%) closely followed by the companies with $2 billion to $10 billion of market cap (36.9%).

The fund apparently seeks to mirror the index by investing at least 80% of its total assets and seeks to have at least 85% similarity with the index’s performance.

Security-wise, the index has less company-specific concentration with 6.57% of holdings invested in top 10 assets. No single stock accounts for more than 0.89% of the total. Sector-wise, information technology takes up the top spot in the index with 18.4% of exposure.

Apart from this, financials (16.3%), consumer discretionary (12.3%), industrials (11.8%), health care (11.7%) and energy (10.9%) get double-digit allocations. It should also be noted that the number of stocks per industry is limited to 10, so there looks to be a solid level of diversification and it could be a broad play out in the U.S. equities’ space.

How does it fit in a portfolio?

This ETF could be appropriate for investors seeking a new way to play the U.S. that has a tilt toward lesser capitalization and high-flying sectors. We all know that companies belonging to cyclical sectors tend to perform better in a growing economy and so do the stocks with smaller cap levels (read: Best ETF Strategies for 2014).

Normally, relatively smaller companies pickup faster than the larger ones in a growing economy. Also, with a major focus on the domestic market, smaller firms are poised to surge in a trending U.S. market against larger counterparts which generally have a global exposure. As a result, we believe pure U.S. exposure can best be achieved via pint-sized securities.

However, lesser capitalization does not necessarily imply high risk, at least for this fund, as the index tries its best to avoid all sorts of concentration risks. An almost equal-weighted approach and diversification are the major positives for this fund.

ETF Competition

In terms of competition, the multi-cap U.S. equities space has a great deal of products striving for investor money. However, the majority of the U.S. focused big funds target the large-cap segment the most thus not falling within the group of direct competitors.

Some of the most likely competitors are Barron's 400 ETF (BFOR), Morningstar US Market Factor Tilt Index Fund (TILT) and MSCI USA Size Factor ETF (SIZE) though these funds are relatively young in the market and have greater coverage on large caps (read: ALPS Launches Barron's 400 ETF).

Given this excessive large-cap focus in the U.S. multi-cap space, investors might want to try a different way to play the improving U.S. market. And, given the present condition of the U.S. market, when could be a better time to bet some cash on smaller companies?

Thus, we expect VUSE to garner a decent level of inflows thanks to its uniqueness in capitalization and stock screening procedure. To attract new investors, VUSE should sell its diversification points as well, as this will be one of top ways this new fund can compete in what is already an extremely crowded market.

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BARRONS-400 ETF (BFOR): ETF Research Reports
 
ISHRS-MSCI USSF (SIZE): ETF Research Reports
 
FLEXS-MRN USMFT (TILT): ETF Research Reports
 
VID-INT EQ FD (VIDI): ETF Research Reports
 
VID-COR US EQTY (VUSE): ETF Research Reports
 
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