Monday, April 10, 2006

First Trust files prospectus for ETF based on Cost of Capital

First Trust has filed a tentative prospectus for the "First Trust DB Strategic Value Index Fund" ETF. This fund will track the Deutsche Bank CROCI US+ Index. The CROCI Index is an equal weight index containing forty stocks selected from the 251 largest stocks in the S&P 500, based on economic value added.

The forty stocks are selected on their ability to earn cash profits above and beyond the weighted average cost of capital. The fund uses Deutsche Bank's Cash Return on Invested Capital methodology to calculate a companies real profits and cash cost of its capital assets (including costs to create capital intangibles such as brands and accumulated R&D). For companies with positive economic earnings, an economic price to economic earnings ratio is calculated, and the 40 stocks with the lowest economic P/E ratios are included in the index.

This is the first exchange traded fund to publicly use an economic value added [EVA] methodology to select companies. The "First Trust DB Strategic Value Index Fund" will be a large/mega cap value index fund focused on highly profitable companies with strong operating margins. The current Deutsche Bank CROCI US+ Index constituents are listed on the AMEX website.

I applaud First Trust for starting an ETF based on the best thinking in corporate finance and fundamental indexing. Joel Greenblatt's best selling Little Book That Beats the Market is based on picking stocks that can earn more than the cost of capital used by the company. Assuming that the management fees are not excessive, this ETF based on companies with real cash profits has real potential to outperform other index funds based on market cap weighted indices.


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