AlphaDEX ETFs Do Things Differently With Stellar Results

First Trust, the Illinois-based ETF sponsor, is a major issuer of sector funds. As most investors know, there is no shortage of sector ETFs on the market today and this territory long dominated by the biggest fund sponsors, namely State Street's (NYSE:STT) select sector SPDRs along with sector funds issued by iShares and Vanguard.

That is tough territory to encroach upon, but First Trust has done just that with its AlphaDEX funds that eschew the usual cap-weighting methodology in favor of using other valuation metrics to construct ETF indexes.

The strategy has proven efficacious. Not only have an array of First AlphaDEX ETF proven proficient in terms of gaining assets under management, some have outperformed iShares, SPDR and Vanguard rivals over time.

"We're more selective in our approach," said First Trust ETF Strategist and Senior Vice President Ryan Issakainen in an interview with Benzinga from the Morningstar ETF Conference in Chicago. "We're overweighting in terms of investment merit. Over time, these attributes predict relative outperformance. We consider momentum and valuation factors that have been vetted and passed through some rigor."

The AlphaDEX methodology includes ranking members of various Russell 1000 sectors on growth factors including three, six and 12-month price appreciation, sales to price and one year sales growth, and, separately, on value factors including book value to price, cash flow to price and return on assets, as First Trust notes on the AlphaDEX funds' web sites.

AlphaDEX has worked for some First Trust sector funds. For example, the First Trust Materials AlphaDEX Fund (NYSE:FXZ) has outpaced the Materials Select Sector SPDR (NYSE:XLB) over the past year, quarter and year-to-date.

Still, the AlphaDEX funds are not as large as their counterparts and in most cases are not as voluminous. The First Trust AlphaDEX Energy Fund (NYSE:FXN) has $134.5 million in AUM compared to $7.2 billion for the Energy Select Sector SPDR (NYSE:XLE). The First Trust AlphaDEX Health Care Fund (NYSE:FXH) has average daily volume of 138,000 shares while Health Care Select Sector SPDR (NYSE:XLV) has average turnover of almost 4.8 million shares.

Issakainen notes that the AlphaDEX ETFs have been well received by investors.

"The ETFs are penetrating registered investment advisors and asset management firms," he said. "They're using AlphaDEX funds more now. The AlphaDEX sector funds have been out for more than five years and we now how they perform in different environments."

The statistics support Issakainen's view that investors are warming to the AlphaDEX methodology. FXH has $642.5 million in AUM. The First Trust Consumer Staples AlphaDEX Fund (NYSE:FXG) has $360.9 million in assets. The First Trust Financials AlphaDEX Fund (NYSE:FXO) has nearly $187 million in assets. Those are all numbers that imply the AlphaDEX sector funds are not only surviving, but thriving as well.

Due to AlphaDEX sector funds avoiding excessive weights to just one or two stocks, there are times when the funds can lag traditionally weighted ETFs. The technology sector provides a good example.

Year-to-date,the First Trust Technology AlphaDEX Fund (NYSE:FXL) is up 8.3 percent. FXL currently has a weight of just 1.9 percent to Apple. On the other hand, the iShares Dow Jones U.S. Technology Sector Index Fund (NYSE:IYW) is up nearly 19 percent this year. That fund features the largest allocation of any ETF to Apple with a current weight of 24.2 percent.

"There will be times when AlphaDEX funds trail, particularly during risk averse environments," said Issakainen. "If we're underweight big, safe stocks, we can underperform, but that is not the case the majority of the time."

He is right about that. Over the past five years, a brutal time for bank stocks, FXO is off 16.3 percent compared to a 53 percent plunge for the Financial Select Sector SPDR (NYSE:XLF). Since May 2007, the debut month of FXH, that ETF has surged over 70 percent, but XLV is up just 14 percent. In the past year, FXN has delivered almost 400 basis points in additional alpha compared to XLE and has topped the Vanguard Energy ETF (NYSE:VDE) by more than 500 basis points.

For more on AlphaDEX ETFs, click here.