FXG: First Trust Consumer Staples AlphaDEX ETF

FXG: First Trust Consumer Staples AlphaDEX ETF

The First Trust Consumer Staples AlphaDEX Fund (NYSEARCA: FXG) is an exchange-traded fund, or ETF, that attempts to reproduce returns and yields that generally correspond to an equity index called the StrataQuant Consumer Staples Index, or the underlying index. This index is a modified equal dollar-weighted index, meaning it separates stocks into tiers and then weights the holdings in each tier equally.

The underlying index is relatively picky about selected stocks, using what the fund describes as a "multifactor selection process" to identify value stocks with growth potential; it searches for value first, then growth. In the jargon of fundamental analysis, a value stock is one that carries an intrinsic value greater than its present market value. A growth stock normally refers to companies that reinvest dividends and make capital investments to increase the size of future operations.

FXG's basket of stocks tilts toward mid caps, which makes some sense given that huge companies rarely possess strong growth potential. Almost all stocks are selected from the Russell 1000 Index, which itself is a subset of the Russell 3000 Index. The Russell 3000 tracks approximately 3,000 of the largest companies in the United States. FXG is composed entirely of domestic equities.

The fund focuses on consumer staples companies. These refer to the producers of common, inelastic consumer goods, such as inexpensive food, beverages, essential appliances and tobacco. Such goods are considered to always be in demand, regardless of the health of the overall economy. Most investors who choose consumer staples are looking for slow, low-volatility growth.

How It Tracks It

The multifactor selection process for the underlying index is what makes FXG a little unique. This index is known as an enhanced product and is developed by the New York Stock Exchange Euronext. The word "AlphaDEX" in the fund title is a reference to the proprietary AlphaDEX stock selection methodology applied with this ETF.

Even though this is an indexed fund, it is not as vanilla as many other indexed mutual funds or ETFs. This opens the possibility for unique, or at least interesting, fund performance, but it can also lead to higher fund costs.

There are only 40 different holdings in FXG. This is low for an ETF but about average for the fund category. Not surprisingly, FXG can be top heavy. The top 10 holdings account for just under half of all assets; again, this is not out of line with the category. The vast majority of holdings are classified as consumer defensive, but anywhere from 3 to 8% may be invested in health care stocks.

Most top holdings are in the food products segment, including six of the top eight. There are nine stocks with a weighting of at least 4%: ConAgra Foods at 4.74%; Tyson Foods Class A at 4.71%; CVS Health Corporation at 4.7%; Archer-Daniels-Midland Company at 4.51%; The Hain Celestial Group at 4.43%; The WhiteWave Foods Company Class A at 4.38%; Edgewell Personal Care Company at 4.36%; Ingredion, Inc. at 4.27%; and Constellation Brands Inc. Class A at 4.09%.

Management

FXG is managed and advised by First Trust Advisors LP, and its servicing agent is Bank of New York Mellon. First Trust is known for its innovative and statistics-driven approach to creating investment funds. First Trust released FXG in May 2007 and, as of August 2015, the fund had accumulated $2.94 billion in assets under management, or AUM. The fund trades on the NYSE and dividends are released quarterly.

Characteristics

There is no question this is a peculiar fund with plenty of investor interest. However, FXG is not going to win any medals for efficiency or tracking ability. It carries a sector-high expense ratio at 0.7%, a number that has increased from 0.67% since January 2014. The category average for an administrative fee is 0.45%.

There are no issues with FXG's liquidity or tradability, except traders might just find better alternatives elsewhere in the market. The fund has a median daily volume of 283,000 worth around $12.75 million, which is more than enough for any retail trader. Spreads are very low at 0.04%. and discounts/premiums are even smaller.

Do not pay as much attention to tracking error or "goodness of fit" data with this ETF. FXG is designed to pick winning equities in the consumer staples sector, not to follow it blindly. In other words, it is inappropriate to treat it like other passive ETFs.

Suitability and Recommendations

The consumer staples emphasis means FXG should perform much better than the broader market during tough economic times. Historically, the fund has done just that: perform very well in recessions and underperform in early stages of the economic cycle. It is a good fit for conservative investors, bearish investors or those who have a relatively short investment horizon.

Even though FXG is relatively defensive compared to a standard equity fund, it still does not offer the same kind of price stability as a bond fund, or better yet, an actual bond. There is some risk in any ETF emphasizing one sector too strongly, although consumer defensive is perhaps the least risky of all sectors in this regard.

Younger or less-conservative investors do not want to make FXG a large core holding, but it can be a nice satellite hedge or something to pick up when the markets are nervous, such as when the yield curve inverts.

Fund-rating companies such as Morningstar give FXG high grades, or in Morningstar's case, five stars. As of August 2015, FXG has a trailing 60-month beta of 0.62 and an alpha of 13.17, which are very impressive numbers.

How a Financial Adviser Client Could Use This ETF

FXG is not a difficult ETF to place for financial adviser clients. Conservative and cautious investors like the above-average upside capture and the very low downside capture. The concept of slow and steady plays well with most clients, particularly those who lost large portions of their portfolio in the financial crisis of 2007-2008.

This should also be considered as a countercyclical counterweight to a broader or more aggressive U.S. equities portfolio. There is enough liquidity in FXG to serve as a trading tool, though the fund is not necessarily designed for that.

Main Competitors and Alternatives

There are only two competitor ETFs with enough AUM to compete with FXG, but neither of them have the AlphaDEX advanced selection methodology. The first and largest is the Consumer Staples Select Sector SPDR, which has close to $8 billion in total assets and almost 20 times the trading volume of FXG. The other is Vanguard's Consumer Staples ETF, which is a good alternative for those looking for low-cost options.