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New ETFs Overweight Top Revenue-Generators

His firm may sponsor only three small exchange-traded funds right now, but if Sean O'Hara, president of RevenueShares Investor Services of Paoli, Pa., has his druthers, there'll be revenue-weighted ETFs in every investor's portfolio someday. With that in mind, the firm will be offering 10 additional sector ETFs within weeks, with more to come later this year.

RevenueShares is the first ETF sponsor to launch so-called fundamental ETFs that exclusively look to companies' top-line revenue figures.

Purely based upon that single metric, a company's revenue, the investment advisor will determine how large a component each company will be in the underlying index each ETF tracks.

Unlike other ETF providers that have built their very own proprietary indexed ETFs based upon a series of fundamental metrics, such as dividends or earnings, RevenueShares has no desire to devise its own proprietary index.

Rather, it has chosen to start with three well-known, traditional, capitalization-weighted equity indexes from Standard & Poor's under a licensing arrangement. S&P has reconfigured those three indexes so that companies with greater revenues represent a greater relative weighting in each index.

In their original format, the S&P indexes are cap-weighted, meaning that companies' index weightings are in direct proportion to their market capitalizations. The greater a company's capitalization, as driven by its share price, the larger the allocation it commands within the index.

"Revenue as a metric is a very effective way to weight an index," O'Hara said. "Revenue tends to focus on the size of the company's business, not the market cap." That concept allows for the ETFs to essentially own fewer shares of overpriced stocks and allocate greater percentages to underpriced stocks, O'Hara noted. The goal is to generate ETF performance that is better over the long term than the performance of each index's cap-weighted cousin.

The RevenueShares Large Cap ETF tracks to a revenue-weighted version of the ubiquitous large cap S&P 500, while the RevenueShares Mid Cap ETF tracks to a revenue-weighted version of the S&P 400 Mid Cap Index, and the RevenueShares Small Cap ETF tracks to the S&P Small Cap 600 Index, revised to adhere to revenue weightings. All three ETFs debuted on Feb. 22 trading on the New York Stock Exchange's electronic ARCA exchange. The underlying indexes will be rebalanced annually.

The group, which has tapped VTL Associates as its advisor and BNY Advisors of New York as sub-advisor, expects to launch 10 additional S&P sector ETFs within the next few months, O'Hara said. In addition, the firm's executives are in discussions with other well-known index providers to adapt other indexes to the revenue-weight model that RevenueShares prefers and hangs it brand on.

The three flagship ETFs are still in their infancy and currently have collective assets of $65 million. O'Hara said he is seeing daily net inflows of between $12 million and $15 million but expects that to increase as the revenue-driven ETF concept catches on with financial intermediaries with whom RevenueShares is talking.

The firm has targeted advisers who sell their advisory services through platforms and registered investment advisers, and by mid-June expects to have a sales force in place that includes 13 external wholesalers and 10 internal wholesalers. Sales efforts include in-the-field wholesaler visits, webinars and about 70,000 direct mailers to advisers per week. A year from now, O'Hara expects to have a bigger sales organization and a broader product lineup.

The firm's focus is not on the ETF products themselves, but, rather, on showing how such revenue-weighted ETFs fit within clients' portfolios, even alongside those much beloved cap-weighted indexes RevenueShares has sliced and diced, O'Hara added.

In April 2003, Rydex Investments of Rockville, Md., was the first to offer an ETF that tosses aside market caps and embrace non-discriminatory equal weightings for all constituents of the S&P 500 index. Five years later, the Rydex S&P Equal Weight ETF has proven itself and its equal-weighting concept.

Similar to RevenueShares' current plans, Rydex launched nine equally weighted S&P sector ETFs (the telecom sector was combined with the utilities sector) 3-1/2 years later, in November 2006.

"I think it makes sense to move away from cap-weighting," said Ed Lopez, director of ETF strategies at Rydex. That departure allows for both the index and the tracking ETF to have more of a small-cap bias as well as a value bias, which ordinarily wouldn't be the case with the giants dominating cap-weighted indexes, he said. That has the potential to enhance performance over the longterm, according to Lopez.

"Fundamentally weighted indexes which weight by different factors may have their day. But what equal-weighting does is randomize those factors," he argued.

Lopez also believes that investment products tracking to cap-weighted indexes can and should peacefully co-exist alongside the more nouveau indexed products designed to capture a momentum strategy boost.

Whether ETF managers look to company sales, net revenues, dividends, earnings a combination thereof, or apply equal-weightings, "they're making a series of small, carefully calibrated bets via the weighting scheme," said Jeffrey Ptak, director of ETF analysis at Morningstar. "Of the various methods, I would say that revenue-weighting is probably the least compelling, as sales only tell part of the story. By contrast, earnings and dividends come directionally closer to expressing a firm's bottom-line profitability," Ptak commented.

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