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

If you're looking to diversify your investment portfolio with small-cap stocks, FYX is worth considering. The First Trust Small Cap Core AlphaDEX Fund (FYX) provides exposure to U.S. small-cap stocks using an enhanced indexing strategy aimed at capturing more substantial potential returns. Today, we'll explore what FYX is, along with its advantages and disadvantages, to help you determine if it fits your investment goals.

What is FYX?

FYX is an ETF that aims to provide investment results corresponding to the performance of the NASDAQ AlphaDEX Small Cap Core Index. Unlike traditional indexing methodologies, this ETF uses a proprietary selection process designed to pick stocks that are expected to outperform the broader small-cap market.

Key Features of FYX

  • Enhanced Indexing: FYX uses the AlphaDEX stock selection methodology, which evaluates companies based on various growth and value factors. The selection criteria aim to identify stocks with higher investment potential rather than simply tracking a small-cap index.
  • Small-cap Focus: This ETF specifically targets small-cap companies, providing exposure to a segment of the market often overlooked by larger, broad market ETFs.
  • Diversification: FYX holds a diverse array of small-cap stocks spread across different sectors, offering a balanced approach to small-cap investing.

FYX Composition

FYX comprises top small-cap stocks selected based on a rigorous evaluation process. Some typical sectors well-represented in FYX include consumer discretionary, industrials, and healthcare. This diversified approach reduces the risk associated with individual stock volatility while still capturing the growth potential inherent in small-cap stocks.

Pros of FYX

Potential for Higher Returns

Small-cap stocks are known for their potential for higher returns compared to their large-cap counterparts. These companies typically have greater room for growth and can benefit significantly from positive economic conditions.

Unique Selection Methodology

The AlphaDEX methodology provides an edge over traditional small-cap index funds by selecting stocks based on several performance metrics. This strategy can lead to outperforming a standard small-cap index over the long term.

Sector Diversification

FYX offers broad exposure across various sectors, reducing sector-specific risks. This diversified approach helps balance the portfolio and minimizes the impact of downturns in any particular industry.

Cons of FYX

Higher Volatility

Small-cap stocks can be more volatile than large-cap stocks. FYX's composition of small-cap companies can experience significant price swings, leading to a potentially more volatile investment compared to large-cap ETFs.

Higher Expense Ratio

While FYX offers a unique investing approach, it comes with a relatively higher expense ratio of 0.70%. This fee is higher than those of many passive ETFs, which could erode returns over the long term.

Limited Historical Data

The performance history of FYX is not as extensive as some well-established large-cap ETFs. Investors need to be cautious and understand that past performance might not necessarily predict future results, especially in a more volatile segment like small caps.

FYX Investment Strategies

Investing in FYX necessitates a strategic approach due to its unique characteristics and the volatility associated with small-cap stocks.

Long-term Investment Strategy

To maximize the benefits of FYX, a long-term investment horizon of at least 10 years is advisable. The potential for higher returns in small-cap stocks often requires time to materialize. A long-term investment approach can help ride out volatility and capture the growth potential of small-cap companies selected through the AlphaDEX methodology.

Dollar-Cost Averaging

Given the volatility of small-cap stocks, adopting a dollar-cost averaging strategy—investing a fixed amount regularly—can help mitigate the risk of investing a lump sum at a potentially inopportune time. This strategy smooths out the purchase price over time and reduces the impact of market volatility.

Diversification Within a Portfolio

FYX should be considered as part of a broader, diversified investment portfolio. While FYX offers exposure to small-cap stocks, balancing it with large-cap and international equities can reduce overall portfolio risk and improve the risk-adjusted return profile.

Reinvestment of Dividends

Reinvesting dividends by using the money to buy more FYX shares can harness the power of compounding. Over time, this strategy can lead to significant growth, enhancing the overall return on investment.

Conclusion

FYX presents an intriguing option for investors looking to gain exposure to small-cap stocks with a unique stock selection methodology. While it offers potential for higher returns and diversified sector exposure, it also comes with higher volatility and a higher expense ratio. For long-term investors willing to embrace some risk, FYX can be a valuable component of a diversified portfolio, especially when combined with strategies like dollar-cost averaging and dividend reinvestment.

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