This Undiscovered ETF Brings it Home for Investors

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There are more than 1,450 ETFs out there, running the gamut from oddities like Japanese hedged equity funds to plain vanilla index funds.

In between A and Z are a few undiscovered style and strategy ETFs that post impressive long-run returns without attracting much attention from Wall Street.

This under-owned ETF has killed it since 2007

One of the best performing exchange-traded funds on Wall Street comes from Invesco Powershares. Allow me to introduce you to the $400 million PowerShares Buyback Achiever Portfolio (NYSEMKT: PKW).

This fund tracks a little-known index called the NASDAQ Buyback Achievers Index, which has rigid buy and sell rules based on share repurchases. The index uses a methodology which selects stocks that trade on an American exchange, and have repurchased at least 5% of their total shares outstanding in the past 12 months.

The fund holdings are then rebalanced quarterly, with constituents weighted by market cap to make this a very top-heavy, large cap fund.

So far, the Buyback Achiever Portfolio ETF has performed excellently against the broad market. Here's the fund charted against the SPDR S&P 500 ETF:

<img alt="" src="http://media.ycharts.com/charts/49177abeb84b6e4fe8341ab99139cca2.png" />

PKW data by YCharts

The chart of the two highlights the obvious:

  1. Buybacks have been a great way for investors to ride the momentum of repurchases to higher total returns. Buying back shares is an easy way for companies to drive EPS. The year 2013 has been marked by aggressive share repurchases. Apple, as well as several blue chip names, are repurchasing shares to create shareholder value. A strategy built on buying companies that are most aggressive with repurchases has performed exceptionally well.
     
  2. The buyback achievers fund is very much correlated to the performance of the S&P 500 SPDR (NYSEMKT: SPY). Public data yields a beta of .96 for buyback achievers, implying that companies which are the most aggressive in their repurchase programs are less volatile than the S&P 500, yet have, through the fund's history, provided above-market returns. All of the top 10 companies in the buyback achievers index are S&P 500 components.

The strategy has also left dividend funds in the dust, cooling the fire of the dividend camp, which argues dividends are necessarily better than share repurchases. The buyback fund delivered a 3- and 5- year return of 59%, and 57%, respectively. Total returns were a respectable 45% and 47% for a 3- and 5-year period for the SPDR S&P Dividend ETF (NYSEMKT: SDY), but still well behind the performance of a buyback strategy. It's not for a lack of diversification either, the buyback achievers fund holds 208 stocks vs. 86 for the dividend fund.

Why the fund outperforms

Chief financial officers of public firms are often criticized for their poor timing of buybacks. In fact, if you look through history, companies are much more likely to repurchase shares at a peak than a trough. Data from FactSet shows this reality: buybacks last peaked when the markets hit their highs in 2007 and 2008.

A share repurchase program is usually enacted with a rosy view on the future. The Powershares Buyback Achievers ETF doesn't stick around to see if that future plays out. Remember, the index and the fund only include companies which have repurchased at least 5% of their outstanding shares in the past twelve months. Once a buyback stops, or slows to a pace slower than 5% of the outstanding share count each year, this fund dumps holdings for greener pastures.

The strategy has a track record of outperformance going back to 1975. Ford Research, the index's creator, studied data from 1975 to 2003, finding that a portfolio of companies that repurchase more than 5% of outstanding shares in the last twelve months beat the performance of the S&P 500 index in 24 out of 28 years. There's reason to believe that record of outperformance won't end any time soon.

To learn more about a few ETFs that have great promise for delivering profits to shareholders, check out The Motley Fool's special free report "3 ETFs Set to Soar." Just click here to access it now.


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