What is FEX? (Pros, Cons, and Strategies)

If you're aiming for substantial growth in your investment portfolio while maintaining diversification, you might want to consider FEX. The First Trust Large Cap Core AlphaDEX Fund (FEX) offers a unique approach to large-cap investing by employing a rules-based, enhanced indexing strategy. In this blog post, we'll delve into what FEX is, its benefits and drawbacks, and discuss various strategies for effective investment.

What is FEX?

FEX stands for the First Trust Large Cap Core AlphaDEX Fund, an exchange-traded fund (ETF) designed to provide exposure to large-cap U.S. stocks using a fundamentally weighted approach. Unlike traditional market cap-weighted indices, FEX follows an enhanced index strategy known as AlphaDEX. This methodology aims to select stocks based on a variety of factors indicative of potential future performance rather than simply on company size.

Key Features of FEX

• Rules-Based Selection: The AlphaDEX methodology screens and ranks companies based on growth factors (e.g., sales to price ratio, one-year sales growth, and three-month price appreciation) and value factors (e.g., book value to price ratio, cash flow to price ratio, and return on assets).
• Quarterly Rebalancing: The fund is rebalanced quarterly to ensure it remains aligned with its underlying enhanced index strategy.
• Diversified Exposure: It offers exposure to both growth and value stocks within the large-cap space, aiming for balanced risk and reward.

FEX Composition

FEX comprises a broad array of U.S. large-cap stocks across various sectors. By selecting companies based on multifactor criteria, FEX tends to include diverse industry leaders that might not be the most well-known names but exhibit strong growth or value characteristics. This includes, but is not limited to, companies in the healthcare, consumer discretionary, financials, and industrials sectors.

Pros of FEX

Enhanced Performance Potential

The AlphaDEX methodology could offer better performance compared to traditional market cap-weighted indices. By focusing on growth and value factors, FEX aims to identify and overweight stocks that are poised for higher returns.

Diversification

FEX promotes diversification by including a balanced mix of growth and value stocks. This diversified exposure helps mitigate risks compared to investing in a narrowly focused ETF or individual stocks.

Systematic Investing Approach

For investors who prefer a systematic, rules-based approach, FEX's quarterly rebalancing ensures that the portfolio remains aligned with its investment criteria and methodology, potentially leading to more consistent performance over time.

Moderate Expense Ratio

FEX offers a moderate expense ratio, which is important for long-term investors aiming to keep costs low. As of the latest data, the expense ratio stands at approximately 0.61%, which is reasonable for an enhanced index fund.

Cons of FEX

Performance Comparability

While the AlphaDEX methodology has outperformed traditional indices in some periods, it may not always beat them. Some traditional market cap-weighted ETFs might deliver better returns in specific market conditions.

Higher Volatility

The factors used in the AlphaDEX methodology can sometimes make FEX more volatile than traditional large-cap funds. Stocks chosen for their growth characteristics might exhibit significant price fluctuations.

Less Tax Efficiency

Due to its quarterly rebalancing, FEX might incur more short-term capital gains, affecting its tax efficiency. This could be a downside for investors looking for tax-efficient vehicles for taxable accounts.

FEX Investment Strategies

FEX is a compelling choice for investors seeking a blend of growth and value stocks within the large-cap segment. Here are some recommended strategies to optimize your investment in FEX.

Long-term Growth Strategy

FEX is best suited for long-term investors seeking substantial growth. The unique stock selection approach aims for enhanced performance, making it suitable for horizons of 5 to 10 years or more. By staying invested over the long haul, you can potentially benefit from the compounded growth and value offered by FEX’s diverse holdings.

Dollar-Cost Averaging

Given its quarterly rebalancing and inherent volatility, a dollar-cost averaging strategy can be beneficial. This involves investing a fixed amount regularly, which can help smooth out the impact of market volatility and reduce the risk of investing a large lump sum at an inopportune time.

Portfolio Diversification

Incorporating FEX as part of a diversified portfolio can offer balanced exposure to large-cap stocks without relying solely on one type of investment approach. Pairing FEX with other asset classes or ETFs with different focuses (such as small-cap or international funds) can further enhance diversification.

Combining with Income ETFs

If you're seeking both growth and income, consider combining FEX with income-generating ETFs. While FEX provides the potential for capital appreciation, complementing it with dividend-paying ETFs can offer steady income, balancing growth and stability in your portfolio.

Conclusion

FEX offers a unique and compelling approach to large-cap investing with its rules-based, enhanced indexing methodology. Although it comes with some drawbacks, such as higher volatility and less tax efficiency, its potential for enhanced performance and diversified exposure make it an attractive option for long-term growth seekers. By employing appropriate strategies such as dollar-cost averaging and thoughtful portfolio diversification, investors can maximize the benefits of FEX while mitigating its risks.