Vanguard is expanding its ETF lineup with the introduction of the AlphaBet series of ETFs, an innovation in the ever-growing ETF space. Together these 26 portfolios, based on the initial letter of the ticker symbol of each company in the Standard & Poor’s 500 Index, provide investors with U.S. equity market beta building blocks by covering the index from A to Z.

Because of the transparent, rules-based nature of the portfolios—constructed with equal-weighted components of all current securities in the S&P 500 whose tickers begin with a particular letter of the alphabet and rebalanced monthly—we have been able to model the historical performance of these portfolios over time to assist investors in understanding how these portfolios may perform. Some observations and strategies:

  • Each of the 26 portfolios outperformed the overall S&P 500 Index.

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Obviously, past performance is not an indicator of future results, and the results don’t reflect any investment that was available during the selected time period (i.e., you can’t predict the future).

We have written about potential biases in preinception performance information; please take note of the methodology in that outperformance might simply be a result of the equal-weighting methodology used—smaller stocks did outperform larger stocks over the period—or that we used current S&P 500 Index constituents, subjecting the analysis to significant hindsight bias.

  • Using these AlphaBet portfolios, one may be able to construct other “betas.” For example, using the portfolios S, M, A, R, and T, an investor can build a SMART-beta using the AlphaBet ETFs. Not surprisingly, this SMART-beta portfolio handily outperformed the S&P 500: 19.6% to 9.4% annualized over the period. And what about the ALPHA portfolio? Yep, it also outperformed the S&P 500 Index, with an annualized return of 18.7%. Even “BETA” outperforms. Go figure.
  • The AlphaBet series of ETFs also allow the creation of personalized “vanity” portfolios. We believe these could be the next frontier in customized ETF portfolio strategies. For example, I built my own “selfie” portfolio. Check out the JOEL portfolio, an equal-weighted combination of the J, O, E, and L AlphaBet ETFs … spectacular returns of 20% annualized over the period.

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We look forward to launching these AlphaBet ETFs for trading before year-end so that you may create investment portfolios for family or friends as a unique holiday gift. We are also intrigued by how you may decide to use these AlphaBet ETFs. Happy investing!

Kidding aside

While this blog post is pure satire, it helps highlight the inherent dangers in some of the approaches being used in product development—specifically the use of niche indexes and historical backtested (or in this case backfilled) information that may be aimed at anchoring expectations of future performance. Its intent is simply to challenge investors of any investment product (including, but not limited to, ETFs, traditional mutual funds, market-cap-weighted approaches, and alternative-weighted approaches) to continue to “look under the hood” in their due diligence process and fully understand the investment rationale, approach, and fit with their own goals and objectives apart from sponsors’ marketing claims and presentations.

Special thanks to Chuck Thomas for helping with the portfolio calculations included in this blog

Notes:

All portfolios were constructed using Thomson Reuters Datastream and were composed of current (as of November 2013) S&P 500 Index constituents. Index constituents were grouped into 26 separate portfolios based on the first letter of their ticker symbols. Each portfolio is equally weighted and rebalanced monthly, and performance is computed over the period December 31, 1994, through October 31, 2013. S&P® and S&P 500® are registered trademarks of Standard & Poor’s Financial Services LLC (“S&P”) and have been licensed for use by S&P Dow Jones Indices LLC and its affiliates and sublicensed for certain purposes by Vanguard. The S&P Index is a product of S&P Dow Jones Indices LLC and has been licensed for use by Vanguard. The Vanguard Fund(s) is not sponsored, endorsed, sold or promoted by S&P Dow Jones Indices LLC, Dow Jones, S&P or their respective affiliates, and none of S&P Dow Jones Indices LLC, Dow Jones, S&P nor their respective affiliates makes any representation regarding the advisability of investing in such product(s).