FXH: First Trust Health Care AlphaDEX ETF

FXH: First Trust Health Care AlphaDEX ETF

First Trust issued the First Trust Health Care AlphaDEX ETF (NYSEARCA: FXH) in 2008. This exchange-traded fund (ETF) is designed to follow the investment results of the StrataQuant Health Care Index. The underlying portfolio for FXH is heavily weighted towards health care providers, biotechnology, pharmaceuticals, and health care equipment and supplies.

The StrataQuant Health Care Index is not a standard equity index. It operates through an enhanced quant-driven formula sponsored by the NYSE Group Inc. The NYSE Group uses an AlphaDEX stock picker to select securities from the Russell 1000 Index, then these funds are classified and rated by performance, and the bottom 25% of selected stocks are subsequently eliminated and kept in the index.

When the AlphaDEX selection process is complete, the underlying index is left with an incredibly balanced portfolio, at least in terms of individual holdings size. The top 10 holdings for FXH range from just 2.14% (Tenet Healthcare Corporation) of the portfolio to 2.34% (Intrexon Corporation). There are approximately 75 holdings in the underlying index at any time.

Ninety-nine percent of the StrataQuant Health Care Index is invested in the United States; the other 1% offers exposure to Ireland. Heavy U.S.-weighting is common for the category.

Through this methodology, FXH avoids heavy weighting to the massive pharmaceutical conglomerates that make up most other health care funds. The average ETF in this category tends to be large-or even giant-cap sensitive, but FXH is heavily tilted towards mid-caps.

Characteristics

FXH operates as an open-ended investment company under the Investment Companies Act of 1940. It is categorized within the health care fund category and is advised by First Trust Advisors LP. The Bank of New York Mellon acts as its servicing agent.

This fund does run on the expensive side. Administrative fees come in at 70 basis points (0.7%), which leads the entire fund category. Costs would likely be higher were it not for a contractual cap placed on the expense ratio at 0.7% until Nov. 30, 2015. Expense ratios do not include brokerage fees or other trading costs.

FXH is a large ETF, with more than $4.2 billion in assets under management (AUM). It's also very liquid; the fund has more than 60 million outstanding shares and trades in excess of 1.3 million times per day.

Investors can find the First Trust Health Care AlphaDEX fund trading on the New York Stock Exchange Arca. There are multiple trading platforms that allow for commission-free transactions on the NYSE.

Suitability and Recommendations

As a sector-specific ETF, FXH investors run the risk of over-exposure to the health care industry. Fortunately, health care is not a particularly volatile sector and does not generally suffer as much as the overall stock market during economic stress.

As far as modern portfolio theory (MPT) goes, FXH is a veritable star. It carries a trailing three-year beta of 0.66, and the beta only increases to 0.7 when increased to a five-year window. The alpha rating is similarly stellar: a three-year alpha above 20 and a five-year alpha above 17. The standard deviation – another version of tracking historical volatility – is only 11.46. These numbers might be a little inflated (the R-squared only comes in at 52.09), but overall, this fund has exceeded its expected performance.

All told, FXH is best suited as a satellite position in a broader portfolio, and it can reasonably be increased as a defensive hedge during times of economic trouble. By all accounts, this is a well-managed fund with a complicated but successful indexing methodology. Like many advanced products, FXH comes with a higher price tag than many of its competitors. FXH makes a plausible long-term buy within a well-diversified strategy.

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