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Staple This Hot ETF to Your Buy List

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Use "smart beta" when selecting consumer staples ETFs for the long-term.

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The consumer staples sector is not generally viewed as an exciting area of the market. If asked, most investors would probably prefer the exhilaration of a cutting-edge electric car manufacturer like Tesla Motors (NASDAQ:TSLA) over a company that produces diapers like Procter & Gamble (NYSE:PG). However, there is something to be said for the safety of companies with steady non-cyclical demand, stalwart dividends, and proven business models. In addition, consumer staples stocks typically have lower volatility than other fast-paced sectors of the market.

So far this year the SPDR Consumer Staples ETF (NYSEARCA:XLP) has gained more than 24%, which has been good enough to keep pace with the broader SPDR S&P 500 ETF (NYSEARCA:SPY). With nearly $6 billion in total assets, XLP is by far the largest exchange-traded fund in the consumer staples space. This ETF holds 42 large-cap stocks whose top-three holdings include Procter & Gamble, Coca-Cola (NYSE:KO), and Philip Morris (NYSE:PM). XLP is an excellent benchmark for this sector; however the key to enhancing your portfolio returns is to select companies with the right mix of growth to outperform their peers. Fortunately it has never been easier to find an ETF that does just that.

The First Trust Consumer Staples AlphaDEX Fund (NYSEARCA:FXG) is constructed on an enhanced index strategy that screens stocks based on a number of fundamental factors. According to the fund providers' website, FXG selects stocks which are members of the Russell 1000 Index (INDEXRUSSELL:R1RGSFS) on growth factors including 3-, 6-, and 12-month price appreciation, sales to price, and 1-year sales growth, and, separately, on value factors including book value to price, cash flow to price, and return on assets. It then screens out the bottom quartile and weights the consumer staples companies according to the highest rankings.



The unique index construction methodology has produced excellent returns year-to-date. FXG has gained nearly 40% in 2013, which is more than 15% better than XLP. This is primarily based on its outsized bias towards mid-cap stocks which have outperformed large-cap names this year. The top-three holdings in FXG include the following: Safeway (NYSE:SWY), Whole Foods Market (NASDAQ:WFM), and GNC Holdings (NYSE:GNC).

In addition, the table below shows just how well FXG has performed vs. the S&P 500 Consumer Staples Index (INDEXSP:SP500-30) over the last one, three, and five years.



It is worth noting that the expense ratio to own this ETF is currently the highest in the consumer staples category at 0.71%. However, based on the prevailing trend of outperformance, I believe in this instance that the premium price has been well earned. In addition, according to Index Universe, FXG has attracted more than $139 million in new assets this year compared to over $800 million in outflows from XLP. Based on that evidence, ETF investors are voting on "smart beta" to boost their returns in this sector.

Given the lofty heights of the stock market, I am not yet ready to give an unequivocal buy recommendation on this ETF right here. I would prefer to add this holding to your watch list and purchase it on a modest pullback to improve your chances for a successful long-term holding. A little bit of patience will be well rewarded when an opportunistic entry point presents itself.

Read more from David Fabian, Managing Partner at FMD Capital Management:

The Best ETFs To Navigate Choppy Interest Rate Waters

Bond Bulls Are Back In Control

CEF Investors: Your Window Of Opportunity Is Beginning To Close


Twitter: @fabiancapital
No positions in stocks mentioned.
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