When choosing an ETF, rather than simply looking only at the name or rate of return, it is important to understand first from what method it selects stocks and on which industry it concentrates. Especially because financial stocks respond quickly to interest rates, the economy, and policy changes, even the same financial ETF can have quite a different character depending on the operating structure.
In this article, by taking FXO as an example, we will organize step by step what this product tracks, in what points it is differentiated from general financial ETFs, and how the strengths and burden factors should be viewed together.
Understanding first from the identity of FXO
The official name of FXO is First Trust Financials AlphaDEX Fund. The ticker is FXO, and as can be known from the name, it is an ETF composed centered on the financial sector.
However, this product is different from the traditional method of simply containing large financial stocks according to market capitalization weights. The core point is that it selects stocks and adjusts weights by utilizing the smart beta system called AlphaDEX.
Ticker and product name
It is traded under the code FXO in the U.S. market, and the identifier that investors check first on the screen is exactly this ticker.
The official product name First Trust Financials AlphaDEX Fund can be seen as a name that shows at once the manager, investment target, and even strategic color.
Differences from general financial ETFs
Many sector ETFs choose a structure that contains more of stocks with large market capitalization. On the other hand, FXO has a strong character of selecting stocks according to certain rules, scoring them, and constructing the portfolio.
That is, even if the big frame of investing in the financial sector is the same, it is easy to understand that in the process of deciding which companies to contain with more weight, a more active selection element enters.
What financial companies does it invest in
FXO tends to look broadly at the entire financial industry. It is not a product that contains only banks, and stocks across overall financial services such as insurance companies, asset management companies, and securities-related companies can become targets for inclusion.
Thanks to this structure, rather than leaning only to one industry, it has the characteristic of containing together several sub-fields within the large category of finance.
Including banks, insurance, and even asset managers
Not only commercial banks and investment banks, but also companies conducting insurance business or companies related to asset management and operation enter the range of inclusion.
Because companies with different profit structures from each other can be mixed even within the financial sector, it is far from a form that relies entirely only on one specific business model.
Possibility of a mix of large caps and small- and mid-caps
In the portfolio, not only well-known large financial companies but also relatively smaller financial companies can be included together.
This combination has the advantage that it can reflect at the same time the stability of large caps and the growth expectations of small- and mid-caps, but depending on changes in composition weights, the felt volatility may also grow.
How does the AlphaDEX methodology work
The biggest characteristic of FXO is the AlphaDEX-based smart beta strategy. Simply put, it can be seen as a rules-based approach located around the middle of passive ETFs that replicate the index as it is and active funds.
This method looks together at various indicators in order to find among financial companies stocks that are likely to show relatively superior characteristics.
Combination of fundamentals and technical indicators
In the stock selection process, not only factors related to the basic strength of a company but also indicators related to market price flow are referenced.
In the end, rather than simply looking only at company size, it can be understood as a structure that narrows down candidates by reflecting together financial characteristics and movements within the market.
What smart beta means
Smart beta is not complete discretionary management but a method of making a portfolio different from the market average according to predetermined rules.
Therefore, FXO has a stronger selective character than traditional index ETFs, and by that much there is also a possibility that performance may appear differently from general financial indexes.
To summarize the core characteristics of FXO
If this ETF is summarized in one sentence, it is a product that concentrates on the financial sector but in stock selection tries to move away from mechanical market capitalization tracking.
Because the two elements of sector concentration and internal diversification exist at the same time, broadly it is a financial stock ETF, but the detailed structure is more three-dimensional than thought.
Financial sector concentration
FXO, unlike broad market ETFs that contain across several industries, focuses on the financial industry.
So factors that directly affect financial company performance, such as the interest rate environment, loan demand, credit conditions, and regulatory changes, can work greatly on performance.
Diversification effect within the industry
Meanwhile, within finance, detailed industries are divided into several branches, so the shocks of individual sub-fields can be shared to some extent.
For example, when bank stocks are weak, there can be sections where other financial service companies relatively hold up well, so compared to single-stock investment, there is room for buffering power to arise.
What are the strengths
The strengths of FXO do not end simply at being an ETF that has grouped financial stocks. The strengths become clear only when it is seen together by what method it selects financial companies and what exposure investors obtain.
Especially smart beta strategy, financial sector specialization character, and aspects of trading convenience and diversification are points often mentioned.
An approach different from only market capitalization
Traditional sector ETFs can have excessively high weights in large companies, but FXO makes an attempt to step away one step from that method.
This shows the reason for the existence of the smart beta strategy in that it does not depend only on market representative stocks and explores the possibility of additional performance.
Easy to efficiently contain the financial sector
The point that one can access the overall financial sector at once without having to pick individual bank stocks or insurance stocks one by one is an advantage easy to understand even for beginners.
Also, because it is in ETF form, generally trading is convenient, and because it is diversified across several financial companies, it can help in reducing single-stock risk.
Weaknesses and burden factors must also be seen together
As much as the strengths are clear, there are also limits. The financial sector itself is an industry sensitive to the flow of the economy, and smart beta ETFs structurally also have room for burden costs to grow larger than general index-type products.
If an investor considers dividends important, it is also necessary to check the point that expectation and reality can be different.
Sensitive to the economy and policy changes
Financial companies can have performance move greatly depending on the interest rate level, bad debt costs, credit risk, and regulatory environment.
Therefore, in periods when economic slowdown or financial market anxiety grows, it is better to keep in mind the possibility that volatility may also expand in FXO.
Limits of cost and dividend attractiveness
The smart beta method can have a more complex management process than simple tracking ETFs, so there is a possibility that it may lead to relatively higher costs.
Also, just because they are financial stocks does not mean high dividends are always guaranteed, so from a dividend-centered perspective, the attractiveness may also be felt lower than expected.
How could it be utilized
FXO is a tool that can be reviewed when one wants to reflect a view on the financial industry condition in a portfolio. However, rather than giving excessive meaning to one product, it is more practical to decide first what role to assign it within the overall asset allocation.
If approached with the three axes of long-term view, combination with other sectors, and regular checking, understanding becomes easier.
Method of viewing from a long-term perspective
In an economic expansion period, loan increase, expansion of capital market activity, and increase of demand for financial services can work positively on financial company performance.
Based on this background, there are also investors who interpret FXO in connection with a long-term growth phase, but the point that large corrections can appear from time to time must be considered together.
Diversified investment and continuous monitoring
Rather than constructing a portfolio with only one financial sector ETF, a method of balancing by using it together with other assets such as technology stocks, healthcare, and broad market ETFs is often utilized.
In addition, only by continuously checking interest rate policy, economic indicators, financial regulation, and ETF composition changes can one avoid missing changes in the character of this product or expansion of risk.
Summary: What investor is FXO suitable for
FXO is an ETF that can draw attention from investors who want a rules-based selection method different from simple market capitalization tracking while focusing on the financial sector. It can include together large financial stocks and small- and mid-sized financial companies, and the point that it accesses various sub-industries such as banking, insurance, and asset management is also a characteristic.
On the other hand, economic sensitivity, possibility of cost burden, and dividend attractiveness that can be lower than expected are clear check points. In the end, this product can be seen as one means of reflecting a view on the financial industry condition, and an approach of utilizing it while continuously checking it within a diversified portfolio fits better.
Tends to fit well for these readers
For people who are interested in the direction of the financial sector but want to reduce the burden of analyzing individual stocks, it can be a structurally easy-to-understand option.
Also, for investors who want to experience a smart beta ETF of a method different from traditional index tracking products, there is also learning value.
Core points to check and move on
When looking at FXO, it is good to check together the financial sector concentration, the selection logic of the AlphaDEX method, the cost level, and the dividend tendency.
If these four are not missed, one can understand the product much more three-dimensionally than approaching it simply by looking only at the name.
