Case Summary

Frank is a 55 year old executive with a $3 million portfolio.  He is happy with the portfolio’s diversification and risk/return profile, but would like to carve out a piece of his investments, say 10% or so, to try and “beat the market”.


Most investors seek returns in line with the overall market or “beta”.  Advanced investors may to try to achieve returns in excess of the market or “alpha”.

Alpha-seeking investors have many options with ETFs. For example, one alpha strategy popularized by Research Affiliates Rob Arnott is called “fundamental indexing”.  The idea is that major indexes are handicapped because they are capitalization weighted which results in heavier exposure to expensive stocks.  The fundamentally weighted approach composes a portfolio based on measures independent from stock price such as revenue, assets or earnings.

Another common method investors use to try to outperform the market is by underweighting lagging sectors of the economy and overweighting stronger sectors.  Sector rotation ETFs frequently rank the sectors and rebalance accordingly.

Long-Short ETFs provide exposure to a strategy that remains 100% invested in a market by shorting out-of-favor securities and over-weighting those with greater appreciation potential.  A common name for these funds are 130/30 funds meaning that the fund achieves a 130% long position by shorting 30% of the market.

Another way to overweight part of the market is with Ultra ETFs which target 200% of the daily return of the benchmark index – the 200% applies to down as well as up

Investors may rely on strategy funds to yield excess returns.  Some strategies are based on empirical evidence of excess returns such as Spin-Offs and Interest Rate Parity arbitrage. Other strategies are proprietary and typically use some combination of fundamental analysis and relative price strength.

Portfolio Recommendations

Frank should consider WisdomTree’s LargeCap Dividend Fund (DLN) which tracks a fundamentally weighted index of the 300 large companies.  The index is weighted to reflect the projected dividend payments for each company in the coming year.

Another option for Frank is the PowerShares Value Line Industry Rotation Portfolio (PYH) tracks an index based on Value Line’s Timeliness ranking of stocks and industries.  The fund invests in the top two stocks in each of the top 25 industries and the top stock in the next 25 rated industries.

If Frank has the time to watch his portfolio closely, he could use the most popular Ultra fund is the $1 billion Ultra QQQ Proshares (QLD).  The fund seeks to return 200% of the daily performance of the NASDAQ-100 index.

A longer term choice for Frank is the PowerShares DB G10 Currency Harvest Fund (DBV) is designed to exploit the trend that currencies associated with relatively high interest rates, on average, tend to rise in value relative to currencies associated with relatively low interest rates by investing in long and short futures positions in 6 of the 10 G10 currencies.