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

If you're keen on diversifying your portfolio and gaining exposure to the energy sector, the First Trust Energy AlphaDEX Fund (FXN) might be worth considering. FXN offers a unique blend of stocks tailored to reflect the performance of the energy sector. Today, we'll explore what FXN is, along with its advantages and disadvantages.

What is FXN?

FXN is an ETF designed to provide exposure to the energy sector by employing a smart beta index strategy. FXN stands for the First Trust Energy AlphaDEX Fund.

FXN tracks the StrataQuant Energy Index, which uses the AlphaDEX methodology—a stock selection process that ranks stocks based on growth and value factors. Unlike many traditional indexes that rely on market capitalization, FXN aims to outperform market-cap weighted indexes by selecting stocks that exhibit strong growth and value characteristics.

Key Features of FXN

• Ranking Methodology: Stocks are ranked based on growth factors like sales growth, book value, and return on assets, as well as value factors such as price-to-book and price-to-sales ratios.
• Rebalancing: The fund is rebalanced quarterly to continually adapt to changing market conditions and maintain a portfolio of high-ranking stocks.
• Diverse Exposure: Encompasses various sub-sectors within the energy industry, including oil & gas exploration, production, equipment, services, and alternative energy sources.

This multi-faceted approach allows FXN to select stocks with the potential for superior performance within the energy sector.

FXN Composition

FXN consists of a wide array of companies within the energy sector. It primarily includes companies engaged in exploration, production, servicing, and provision of equipment within the energy industry. This diverse composition ensures that the fund is not overly reliant on any single segment of the energy market, offering a balanced exposure to the sector's overall performance.

Pros of FXN

Smart Beta Strategy

FXN uses the AlphaDEX methodology, which combines growth and value factors rather than merely tracking market-cap weighted indexes. This strategy can potentially provide higher returns and mitigate risks by focusing on fundamentally strong companies.

Quarterly Rebalancing

With quarterly rebalancing, FXN adapts to market changes more frequently compared to annual rebalancing funds. This ensures that the fund remains aligned with its strategy of investing in the best-performing stocks based on the AlphaDEX criteria.

Sector Diversification

FXN offers exposure across various sub-sectors within the energy industry, including traditional oil and gas as well as renewable energy sources. This diversification can reduce sector-specific risks and potentially stabilize returns.

Competitive Expense Ratio

FXN's expense ratio is relatively competitive within the smart beta ETF niche, making it an attractive option for cost-conscious investors looking for sector-specific exposure.

Cons of FXN

Volatility

The energy sector is inherently volatile, subject to fluctuations in oil prices, geopolitical tensions, and environmental policies. This volatility can lead to significant short-term price swings and impacts on FXN's performance.

Low Dividend Yield

While some energy sector ETFs may offer higher dividend yields, FXN's yield is relatively moderate. Those looking for high dividend income may find FXN less appealing, as its primary focus is on capital appreciation rather than income generation.

Exposure to Commodity Prices

Since FXN invests heavily in the energy sector, its performance is highly correlated with commodity prices such as oil and gas. A downturn in commodity prices can negatively affect the fund's overall return.

FXN Investment Strategies

FXN is suitable for investors seeking growth opportunities within the energy sector without relying solely on market cap-weighted indexes. Below are some strategies to consider when investing in FXN.

Long-term Investment Strategy

Given the volatility inherent in the energy sector, FXN is more suitable for long-term investors who can withstand short-term price fluctuations. Over a longer horizon, FXN's smart beta strategy may pay off, providing superior returns compared to traditional energy sector indexes.

Diversification Strategy

While FXN offers diversification within the energy sector, it should be part of a broader, diversified portfolio. Combining FXN with ETFs from other sectors can help mitigate sector-specific risks and provide a balanced investment approach.

Tactical Allocation

FXN can also be used for tactical allocation within a broader investment strategy. Investors bullish on the energy sector can allocate a portion of their portfolio to FXN to capitalize on anticipated growth within the sector, adjusting the allocation based on market conditions and outlook.

Dividend Reinvestment

For investors focused on capital growth, reinvesting dividends received from FXN can be a powerful strategy. This allows for the compounding effect, potentially enhancing returns over the long haul.

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FXN offers a unique perspective on energy sector investment through its smart beta strategy. While it comes with its share of volatility and sector-specific risks, it provides diversified exposure and the potential for superior growth. By carefully implementing a long-term, diversified investment strategy, FXN can be a valuable addition to a well-rounded portfolio.